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© The McGraw-Hill Companies, Inc., 2018. All rights reserved. Solutions Manual, Chapter 2 1 Chapter 2 Job-Order Costing: Calculating Unit Product Costs Questions 2-1 Job-order costing is used in situations where many different products, each with individ- ual and unique features, are produced each pe- riod. 2-2 In absorption costing, all manufacturing costs, both fixed and variable, are assigned to units of product—units are said to fully absorb manufacturing costs. Conversely, all nonmanufac- turing costs are treated as period costs and they are not assigned to units of product. 2-3 Normal costing systems apply overhead costs to jobs by multiplying a predetermined overhead rate by the actual amount of the alloca- tion incurred by the job. 2-4 Unit product cost is computed by taking the total manufacturing costs assigned to a job and dividing it by the number of units contained in the job. 2-5 The first step is to estimate the total amount of the allocation base (the denominator) that will be required for next period’s estimated level of production. The second step is to esti- mate the total fixed manufacturing overhead cost for the coming period and the variable manufac- turing overhead cost per unit of the allocation base. The third step is to use the cost formula Y = a + bX to estimate the total manufacturing overhead cost (the numerator) for the coming pe- riod. The fourth step is to compute the predeter- mined overhead rate. 2-6 The job cost sheet is used to record all costs that are assigned to a particular job. These costs include direct materials costs traced to the job, direct labor costs traced to the job, and man- ufacturing overhead costs applied to the job. When a job is completed, the job cost sheet is used to compute the unit product cost. 2-7 Some production costs such as a factory manager’s salary cannot be traced to a particular product or job, but rather are incurred as a result of overall production activities. In addition, some production costs such as indirect materials cannot be easily traced to jobs. If these costs are to be assigned to products, they must be allocated to the products. 2-8 If actual manufacturing overhead cost is applied to jobs, the company must wait until the end of the accounting period to apply overhead and to cost jobs. If the company computes actual overhead rates more frequently to get around this problem, the rates may fluctuate widely due to seasonal factors or variations in output. For this reason, most companies use predetermined over- head rates to apply manufacturing overhead costs to jobs. 2-9 The measure of activity used as the allo- cation base should drive the overhead cost; that is, the allocation base should cause the overhead cost. If the allocation base does not really cause the overhead, then costs will be incorrectly at- tributed to products and jobs and product costs will be distorted. 2-10 Assigning manufacturing overhead costs to jobs does not ensure a profit. The units pro- duced may not be sold and if they are sold, they may not be sold at prices sufficient to cover all costs. It is a myth that assigning costs to prod- ucts or jobs ensures that those costs will be re- covered. Costs are recovered only by selling to customers—not by allocating costs.

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Solutions Manual, Chapter 2 1

Chapter 2 Job-Order Costing: Calculating Unit Product Costs

Questions

2-1 Job-order costing is used in situations where many different products, each with individ-ual and unique features, are produced each pe-riod.

2-2 In absorption costing, all manufacturing costs, both fixed and variable, are assigned to units of product—units are said to fully absorb manufacturing costs. Conversely, all nonmanufac-turing costs are treated as period costs and they are not assigned to units of product.

2-3 Normal costing systems apply overhead costs to jobs by multiplying a predetermined overhead rate by the actual amount of the alloca-tion incurred by the job.

2-4 Unit product cost is computed by taking the total manufacturing costs assigned to a job and dividing it by the number of units contained in the job.

2-5 The first step is to estimate the total amount of the allocation base (the denominator) that will be required for next period’s estimated level of production. The second step is to esti-mate the total fixed manufacturing overhead cost for the coming period and the variable manufac-turing overhead cost per unit of the allocation base. The third step is to use the cost formula Y= a + bX to estimate the total manufacturing overhead cost (the numerator) for the coming pe-riod. The fourth step is to compute the predeter-mined overhead rate.

2-6 The job cost sheet is used to record all costs that are assigned to a particular job. These costs include direct materials costs traced to the job, direct labor costs traced to the job, and man-ufacturing overhead costs applied to the job.

When a job is completed, the job cost sheet is used to compute the unit product cost.

2-7 Some production costs such as a factory manager’s salary cannot be traced to a particular product or job, but rather are incurred as a result of overall production activities. In addition, some production costs such as indirect materials cannot be easily traced to jobs. If these costs are to be assigned to products, they must be allocated to the products.

2-8 If actual manufacturing overhead cost is applied to jobs, the company must wait until the end of the accounting period to apply overhead and to cost jobs. If the company computes actual overhead rates more frequently to get around this problem, the rates may fluctuate widely due to seasonal factors or variations in output. For this reason, most companies use predetermined over-head rates to apply manufacturing overhead costs to jobs.

2-9 The measure of activity used as the allo-cation base should drive the overhead cost; that is, the allocation base should cause the overhead cost. If the allocation base does not really cause the overhead, then costs will be incorrectly at-tributed to products and jobs and product costs will be distorted.

2-10 Assigning manufacturing overhead costs to jobs does not ensure a profit. The units pro-duced may not be sold and if they are sold, they may not be sold at prices sufficient to cover all costs. It is a myth that assigning costs to prod-ucts or jobs ensures that those costs will be re-covered. Costs are recovered only by selling to customers—not by allocating costs.

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2 Managerial Accounting, 16th edition

2-11 No, you would not expect the total ap-plied overhead for a period to equal the actual overhead for that period. This is because the ap-plied overhead relies on a predetermined over-head rate that is based on estimates in the nu-merator and denominator.

2-12 When a company applied less overhead to production than it actually incurs, it creates what is known as underapplied overhead. When it applies more overhead to production than it actu-ally incurs, it results in overapplied overhead.

2-13 A plantwide overhead rate is a single overhead rate used throughout a plant. In a mul-tiple overhead rate system, each production de-partment may have its own predetermined over-head rate and its own allocation base. Some com-panies use multiple overhead rates rather than plantwide rates to more appropriately allocate overhead costs among products. Multiple over-head rates should be used, for example, in situa-tions where one department is machine intensive and another department is labor intensive.

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Solutions Manual, Chapter 2 3

Chapter 2: Applying Excel

The completed worksheet is shown below.

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4 Managerial Accounting, 16th edition

Chapter 2: Applying Excel (continued)

The completed worksheet, with formulas displayed, is shown below.

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Solutions Manual, Chapter 2 5

Chapter 2: Applying Excel (continued)

[Note: To display formulas in Excel 2013, select File > Options > Advanced > Display options for this worksheet > Show formulas in cells instead of their calculated amounts. To display the formulas in other versions of Ex-cel, consult Excel Help.]

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6 Managerial Accounting, 16th edition

Chapter 2: Applying Excel (continued)

1. When the total fixed manufacturing overhead cost for the Milling De-partment is changed to $300,000, the worksheet changes as show be-low:

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Solutions Manual, Chapter 2 7

Chapter 2: Applying Excel (continued)

The selling price of Job 407 has dropped from $4,348.75 to $4,112.50 because the fixed manufacturing overhead in the Milling Department de-creased from $390,000 to $300,000. This reduced the predetermined overhead rate in the Milling Department from $8.50 per machine-hour to $7.00 per machine-hour and hence the amount of overhead applied to Job 407 in the Milling Department.

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8 Managerial Accounting, 16th edition

Chapter 2: Applying Excel (continued)

2. For the new Job 408, the worksheet should look like the following:

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Solutions Manual, Chapter 2 9

Chapter 2: Applying Excel (continued)

3. When the total number of machine-hours in the Assembly Department increases from 3,000 machine-hours to 6,000 machine-hours, the work-sheet looks like the following:

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10 Managerial Accounting, 16th edition

Chapter 2: Applying Excel (continued)

The selling price for Job 408 is not affected by this change. The reason for this is that the total number of machine-hours in the Assembly De-partment has no effect on any cost. There would have been a change in costs and in the selling price if the total machine-hours in the Milling De-partment would have changed. This is because the predetermined over-head rate in that department is based on machine-hours and any change in the total machine-hours would affect the magnitude of the predetermined overhead rate in that department.

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Solutions Manual, Chapter 2 11

Chapter 2: Applying Excel (continued)

4. When the total number of direct labor-hours in the Assembly Depart-ment decreases from 80,000 direct labor-hours to 50,000 direct labor-hours, the worksheet looks like the following:

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12 Managerial Accounting, 16th edition

Chapter 2: Applying Excel (continued)

The selling price of Job 408 has increased from $2,905.00 to $2,944.38. This occurs because the decrease in the total number of direct labor-hours in the Assembly Department increases the predetermined over-head rate in that department from $10.00 per direct labor-hour to $13.75 per direct labor-hour. In effect, the same total fixed manufactur-ing overhead cost is spread across fewer total direct labor-hours.

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Solutions Manual, Chapter 2 13

The Foundational 15

1. The first step is to calculate the estimated total overhead costs in Mold-ing and Fabrication:

Molding: Using the equation Y = a + bX, the estimated total manufac-turing overhead cost is computed as follows:

Y = $10,000 + ($1.40 per MH)(2,500 MHs)

Estimated fixed manufacturing overhead .................. $10,000Estimated variable manufacturing overhead:

$1.40 per MH × 2,500 MHs ................................... 3,500Estimated total manufacturing overhead cost............ $13,500

Fabrication: Using the equation Y = a + bX, the estimated total manu-facturing overhead cost is computed as follows:

Y = $15,000 + ($2.20 per MH)(1,500 MHs)

Estimated fixed manufacturing overhead .................. $15,000Estimated variable manufacturing overhead:

$2.20 per MH × 1,500 MHs ................................... 3,300Estimated total manufacturing overhead cost............ $18,300

The second step is to combine the estimated manufacturing overhead costs in Molding and Fabrication ($13,500 + $18,300 = $31,800) to en-able calculating the predetermined overhead rate as follows:

Estimated total manufacturing overhead (a) . $31,800Estimated total machine-hours (MHs) (b)........ 4,000 MHsPredetermined overhead rate (a) ÷ (b)......... $7.95 per MH

2. The manufacturing overhead applied to Jobs P and Q is computed as follows:

Job P Job QActual machine-hours worked (a) ................. 2,300 1,700Predetermined overhead rate per MH (b)...... $7.95 $7.95Manufacturing overhead applied (a) × (b) .... $18,285 $13,515

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14 Managerial Accounting, 16th edition

The Foundational 15

3. The total manufacturing cost assigned to Job P is computed as follows:

Job PDirect materials........................................... $13,000Direct labor................................................. 21,000Manufacturing overhead applied................... 18,285Total manufacturing cost.............................. $52,285

4. Job P’s unit product cost is computed as follows:

Job PTotal manufacturing cost (a) .......................... $52,285Number of units (b)....................................... 20Unit product cost (rounded) (a) ÷ (b)............. $2,614

5. The total manufacturing cost assigned to Job Q is computed as follows:

Job PDirect materials........................................... $ 8,000Direct labor................................................. 7,500Manufacturing overhead applied................... 13,515Total manufacturing cost.............................. $29,015

6. Job Q’s unit product cost is computed as follows:

Job PTotal manufacturing cost (a) .......................... $29,015Number of units (b)....................................... 30Unit product cost (rounded) (a) ÷ (b)............. $967

7. The selling prices are calculated as follows:

Job P Job QTotal manufacturing cost.............................. $52,285 $29,015Markup (based on 80%) .............................. 41,828 23,212Total price for the job (a)............................. $94,113 $52,227Number of units in the job (b)...................... 20 30Selling price per unit (rounded) (a) ÷ (b)...... $4,706 $1,741

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Solutions Manual, Chapter 2 15

The Foundational 15

8. The cost of goods sold is the sum of the manufacturing costs assigned to Jobs P and Q:

Total manufacturing cost assigned to Job P..... $52,285Total manufacturing cost assigned to Job Q .... 29,015Cost of goods sold......................................... $81,300

9. Molding: Using the equation Y = a + bX, the estimated total manufac-turing overhead cost is computed as follows:

Y = $10,000 + ($1.40 per MH)(2,500 MHs)

Estimated fixed manufacturing overhead .................. $10,000Estimated variable manufacturing overhead:

$1.40 per MH × 2,500 MHs ................................... 3,500Estimated total manufacturing overhead cost............ $13,500

The predetermined overhead rate in Molding is computed as follows:

Estimated total manufacturing overhead (a) ... $13,500Estimated total machine-hours (MHs) (b)........ 2,500 MHsPredetermined overhead rate (a) ÷ (b)........... $5.40 per MH

Fabrication: Using the equation Y = a + bX, the estimated total manu-facturing overhead cost is computed as follows:

Y = $15,000 + ($2.20 per MH)(1,500 MHs)

Estimated fixed manufacturing overhead .................. $15,000Estimated variable manufacturing overhead:

$2.20 per MH × 1,500 MHs ................................... 3,300Estimated total manufacturing overhead cost............ $18,300

The predetermined overhead rate in Fabrication is computed as follows:

Estimated total manufacturing overhead (a) ... $18,300Estimated total machine-hours (MHs) (b)........ 1,500 MHsPredetermined overhead rate (a) ÷ (b)........... $12.20 per MH

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16 Managerial Accounting, 16th edition

The Foundational 15

10. The applied overhead from Molding is computed as follows:

Job P Job QMachine-hours worked on job (a) ................. 1,700 800Molding overhead rate (b)............................ $5.40 $5.40Manufacturing overhead applied (a) × (b) .... $9,180 $4,320

11. The applied overhead from Fabrication is computed as follows:

Job P Job QMachine-hours worked on job (a) ................. 600 900Fabrication overhead rate (b) ....................... $12.20 $12.20Manufacturing overhead applied (a) × (b) .... $7,320 $10,980

12. The unit product cost for Job P is computed as follows:

Direct materials .......................................... $13,000Direct labor ................................................ 21,000Manufacturing overhead applied:

Molding Department ................................. $9,180Fabrication Department ............................ 7,320 16,500

Total manufacturing cost (a) ....................... $50,500Number of units in the job (b)..................... 20Unit product cost (a) ÷ (b).......................... $2,525

13. The unit product cost for Job Q is computed as follows:

Direct materials .......................................... $8,000Direct labor ................................................ 7,500Manufacturing overhead applied:

Molding Department ................................. $4,320Fabrication Department ............................ 10,980 15,300

Total manufacturing cost (a) ....................... $30,800Number of units in the job (b)..................... 30Unit product cost (rounded) (a) ÷ (b).......... $1,027

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Solutions Manual, Chapter 2 17

The Foundational 15

14. The selling prices are calculated as follows:

Job P Job QTotal manufacturing cost.............................. $50,500 $30,800Markup (based on 80%) .............................. 40,400 24,640Total price for the job (a)............................. $90,900 $55,440Number of units in the job (b)...................... 20 30Selling price per unit (a) ÷ (b) ..................... $4,545 $1,848

15. The cost of goods sold is the sum of the manufacturing costs assigned to Jobs P and Q:

Total manufacturing cost assigned to Job P..... $50,500Total manufacturing cost assigned to Job Q .... 30,800Cost of goods sold......................................... $81,300

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18 Managerial Accounting, 16th edition

Exercise 2-1 (10 minutes)

The estimated total manufacturing overhead cost is computed as follows:

Y = $94,000 + ($2.00 per DLH)(20,000 DLHs)

Estimated fixed manufacturing overhead .................. $ 94,000Estimated variable manufacturing overhead: $2.00

per DLH × 20,000 DLHs ........................................ 40,000Estimated total manufacturing overhead cost............ $134,000

The plantwide predetermined overhead rate is computed as follows:

Estimated total manufacturing overhead (a)...... $134,000Estimated total direct labor hours (b)................ 20,000 DLHsPredetermined overhead rate (a) ÷ (b) ............. $6.70 per DLH

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Solutions Manual, Chapter 2 19

Exercise 2-2 (10 minutes)

Actual direct labor-hours (a)........................ 10,800Predetermined overhead rate (b)................. $23.40Manufacturing overhead applied (a) × (b).... $252,720

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20 Managerial Accounting, 16th edition

Exercise 2-3 (10 minutes)

1. Total direct labor-hours required for Job A-500:

Direct labor cost (a) ..................................... $153Direct labor wage rate per hour (b) ............... $17Total direct labor hours (a) ÷ (b) .................. 9

Total manufacturing cost assigned to Job A-500:

Direct materials ....................................................... $231Direct labor ............................................................. 153Manufacturing overhead applied ($14 per DLH × 9

DLHs) ................................................................... 126Total manufacturing cost.......................................... $510

2. Unit product cost for Job A-500:

Total manufacturing cost (a)......................... $510Number of units in the job (b)....................... 40Unit product cost (a) ÷ (b) ........................... $12.75

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Solutions Manual, Chapter 2 21

Exercise 2-4 (10 minutes)

1 and 2.

The total direct labor-hours required for Job N-60:

Assembly Testing & Packaging

Direct labor cost (a) ..................................... $180 $40Direct labor wage rate per hour (b) ............... $20 $20Total direct labor hours (a) ÷ (b) .................. 9 2

The total manufacturing cost and unit product cost for Job N-60 is com-puted as follows:

Direct materials ($340 + $25) ................................ $365Direct labor ($180 + $40) ...................................... 220Assembly Department ($16 per DLH × 9 DLHs) ....... $144Testing & Packaging Department ($12 per DLH × 2

DLHs) ................................................................. 24 168Total manufacturing cost........................................ $753

Total manufacturing cost (a) .................................. $753Number of units in the job (b) ................................ 10Unit product cost (a) ÷ (b) ..................................... $75.30

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22 Managerial Accounting, 16th edition

Exercise 2-5 (10 minutes)

1 and 2.

The total direct labor-hours required in Finishing for Job 700:

FinishingDirect labor cost (a) ..................................... $128Direct labor wage rate per hour (b) ............... $16Total direct labor hours (a) ÷ (b) .................. 8

The total manufacturing cost and unit product cost for Job 700 is computed as follows:

Direct materials ($410 + $60) ................................ $470Direct labor ($128 + $48) ...................................... 176Finishing Department ($18 per DLH × 8 DLHs)........ $144Fabrication Department (110% × $60) ................... 66 210Total manufacturing cost........................................ $856

Total manufacturing cost (a) .................................. $856Number of units in the job (b) ................................ 15Unit product cost (rounded) (a) ÷ (b) ..................... $57.07

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Solutions Manual, Chapter 2 23

Exercise 2-6 (10 minutes)

1. The estimated total overhead cost is computed as follows:

Y = $680,000 + ($0.50 per DLH)(80,000 DLHs)

Estimated fixed overhead cost ................................ $680,000Estimated variable overhead cost: $0.50 per DLH ×

80,000 DLHs ....................................................... 40,000Estimated total overhead cost ................................ $720,000

The predetermined overhead rate is computed as follows:

Estimated total overhead (a)...................... $720,000Estimated total direct labor-hours (b) ......... 80,000 DLHsPredetermined overhead rate (a) ÷ (b)....... $9.00 per DLH

2. Total manufacturing cost assigned to Xavier:

Direct materials ....................................................... $38,000Direct labor ............................................................. 21,000Overhead applied ($9.00 per DLH × 280 DLHs)......... 2,520Total manufacturing cost.......................................... $61,520

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24 Managerial Accounting, 16th edition

Exercise 2-7 (20 minutes)

1. Step 1: The total direct labor-hours required for Job Omega:

Direct labor cost (a) ..................................... $345,000Direct labor wage rate per hour (b) ............... $15Total direct labor hours worked (a) ÷ (b) ...... 23,000

Step 2: Derive the plantwide predetermined overhead rate:

Manufacturing overhead applied to Job Omega (a) ................................................ $184,000

Direct labor hours worked on Job Omega (b) . 23,000Plantwide predetermined overhead rate (a)

÷ (b) ........................................................ $8.00 per DLH

2. The job cost sheet for Job Alpha is derived as follows: (note that direct materials is the plug figure)

Direct materials (plug figure)................................. $ 280,000Direct labor (54,500 DLHs × $15 per DLH) ............ 817,500Manufacturing overhead applied ($8 per DLH ×

54,500 DLHs) .................................................... 436,000Total job cost (given) ............................................ $1,533,500

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Solutions Manual, Chapter 2 25

Exercise 2-8 (10 minutes)

Direct material................................ $10,000Direct labor .................................... 12,000Manufacturing overhead applied:

$12,000 × 125% ......................... 15,000Total manufacturing cost ................ $37,000

Total manufacturing cost (a) ........... $37,000Number of units in job (b)............... 1,000Unit product cost (a) ÷ (b).............. $37

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26 Managerial Accounting, 16th edition

Exercise 2-9 (30 minutes)

1. The estimated total overhead cost is computed as follows:

Y = $1,980,000 + ($2.00 per MH)(165,000 MHs)

Estimated fixed overhead....................................... $1,980,000Estimated variable overhead: $2.00 per MH ×

165,000 MHs ...................................................... 330,000Estimated total overhead cost ................................ $2,310,000

The plantwide predetermined overhead rate is computed as follows:

Estimated total overhead (a)...................... $2,310,000Estimated total machine-hours (b) ............. 165,000 MHsPredetermined overhead rate (a) ÷ (b)....... $14.00 per MH

2. Total manufacturing cost assigned to Job P90:

Direct materials ....................................................... $1,150Direct labor ............................................................. 830Overhead applied ($14 per MH × 72 MHs) ................ 1,008Total manufacturing cost.......................................... $2,988

3a. Given that the company is operating at 50% of its manufacturing ca-pacity, an argument can made that the company should pursue any business opportunities that generate a positive a contribution margin. Based on the information provided, it appears that Job P90 does gen-erate a positive contribution margin as shown below:

Sales............................................................... $2,500Direct materials ............................................... $1,150Direct labor ..................................................... 830Variable overhead applied ($2.00 per MH × 72

MHs) ............................................................ 144 2,124Contribution margin......................................... $ 376

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Solutions Manual, Chapter 2 27

Exercise 2-9 (continued)

3b. The CFO’s argument is based on the assertion that Job P90 does not generate enough revenue to cover the cost of the manufacturing re-sources that it consumes. However, given that the company is operat-ing at 50% of its manufacturing capacity, the overhead costs applied to Job P90 in requirement 2 do not represent the cost of the overhead resources consumed making Job P90. In other words, the overhead applied in requirement 2 includes a charge for used and unused capac-ity. This reality provides instructors an opportunity to introduce stu-dents to the main idea underlying Appendix 2B.

If we estimate a capacity-based overhead rate for the company and apply overhead costs to Job P90 using this rate, it reveals that the rev-enue generated by the job ($2,500) is still insufficient to cover its man-ufacturing costs of $2,556, as computed below:

The estimated total overhead cost (at capacity) is computed as follows (keep in mind that 165,000 MHs ÷ 50% = 330,000 MHs):

Y = $1,980,000 + ($2.00 per MH)(330,000 MHs)

Estimated fixed overhead....................................... $1,980,000Estimated variable overhead: $2.00 per MH ×

330,000 MHs ...................................................... 660,000Estimated total overhead cost ................................ $2,640,000

The predetermined capacity-based overhead rate is computed as follows:

Estimated total overhead (a)...................... $2,640,000Estimated total machine-hours (b) ............. 330,000 MHsPredetermined overhead rate (a) ÷ (b)....... $8.00 per MH

The total manufacturing cost assigned to Job P90 (using a capacity-based overhead rate):

Direct materials ....................................................... $1,150Direct labor ............................................................. 830Overhead applied ($8 per MH × 72 MHs).................. 576Total manufacturing cost.......................................... $2,556

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28 Managerial Accounting, 16th edition

Exercise 2-10 (10 minutes)

1. Yes, overhead should be applied to Job W at year-end.

Because $6,000 of overhead was applied to Job V on the basis of $8,000 of direct labor cost, the company’s predetermined overhead rate must be 75% of direct labor cost.

Job W direct labor cost (a)............................................ $4,000Predetermined overhead rate (b) .................................. 0.75Manufacturing overhead applied to Job W (a) × (b) ....... $3,000

2. The direct materials ($2,500), direct labor ($4,000), and applied over-head ($3,000) for Job W will be included in Work in Process on Sigma Corporation’s balance sheet.

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Solutions Manual, Chapter 2 29

Exercise 2-11 (30 minutes)

Note to the instructor: This exercise can be used as a launching pad for a discussion of Appendix 2B.

1. The estimated total fixed manufacturing overhead can be computed us-ing the data from any of quarters 1-3. For illustrative purposes, we’ll use the first quarter as follows:

Total overhead cost (First quarter) ........................... $300,000Variable cost element ($2.00 per unit × 80,000 units) 160,000Fixed cost element .................................................. $140,000

2. The fixed and variable cost estimates from requirement 1 can be used to estimate the total manufacturing overhead cost for the fourth quarter as follows:

Y = $140,000 + ($2.00 per unit)(60,000 units)

Estimated fixed manufacturing overhead .................. $140,000Estimated variable manufacturing overhead

$2.00 per unit × 60,000 units ................................ 120,000Estimated total manufacturing overhead cost............ $260,000

The estimated unit product cost for the fourth quarter is computed as follows:

Direct materials .................................................... $180,000Direct labor ........................................................ 96,000Manufacturing overhead........................................ 260,000Total manufacturing costs (a) .............................. $536,000Number of units to be produced (b) ..................... 60,000Unit product cost (rounded) (a) ÷ (b) .................. $8.93

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30 Managerial Accounting, 16th edition

Exercise 2-11 (continued)

3. The fixed portion of the manufacturing overhead cost is causing the unit product costs to fluctuate. The unit product cost increases as the level of production decreases because the fixed overhead is spread over fewer units.

4. The unit product cost can be stabilized by using a predetermined over-head rate that is based on expected activity for the entire year. The cost formula created in requirement 1 can be adapted to compute the annual predetermined overhead rate. The annual fixed manufacturing overhead is $560,000 ($140,000 per quarter × 4 quarters). The variable manufac-turing overhead per unit is $2.00. The cost formula is as follows:

Y = $560,000 + ($2.00 per unit × 200,000 units)

Estimated fixed manufacturing overhead .................. $560,000Estimated variable manufacturing overhead

$2.00 per unit × 200,000 units .............................. 400,000Estimated total manufacturing overhead cost............ $960,000

The annual predetermined overhead rate is computed as follows:

Estimated total manufacturing overhead (a) $960,000Estimated total units produced (b).............. 200,000Predetermined overhead rate (a) ÷ (b)....... $4.80 per unit

Using a predetermined overhead rate of $4.80 per unit, the unit product costs would stabilize as shown below:

Quarter First Second Third Fourth

Direct materials................. $240,000 $120,000 $ 60,000 $180,000Direct labor....................... 128,000 64,000 32,000 96,000Manufacturing overhead:

at $4.80 per unit ............ 384,000 192,000 96,000 288,000Total cost (a) .................... $752,000 $376,000 $188,000 $564,000Number of units produced

(b) ................................. 80,000 40,000 20,000 60,000Unit product cost (a) ÷ (b) $9.40 $9.40 $9.40 $9.40

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Solutions Manual, Chapter 2 31

Exercise 2-12 (20 minutes)

1. The estimated total manufacturing overhead cost is computed as fol-lows:

Y = $650,000 + ($3.00 per MH)(100,000 MHs)

Estimated fixed manufacturing overhead................. $650,000Estimated variable manufacturing overhead: $3.00

per MH × 100,000 MHs ....................................... 300,000Estimated total manufacturing overhead cost .......... $950,000

The plantwide predetermined overhead rate is computed as follows:

Estimated total manufacturing overhead (a) $950,000Estimated total machine-hours (b) ............. 100,000 MHsPredetermined overhead rate (a) ÷ (b)....... $9.50 per MH

2. Total manufacturing cost assigned to Job 400:

Direct materials ....................................................... $ 450Direct labor ............................................................. 210Manufacturing overhead applied ($9.50 per MH × 40

MHs) .................................................................... 380Total manufacturing cost.......................................... $1,040

3. The unit product cost of Job 400 is computed as follows:

Total manufacturing cost (a)...................... $1,040Number of units in the job (b).................... 52Unit product cost (a) ÷ (b) ........................ $20

4. The selling price per unit is computed as follows:

Total manufacturing cost ........................... $1,040Markup (120% of manufacturing cost) ....... 1,248Selling price for Job 400 (a) ....................... $2,288Number of units in Job 400 (b) .................. 52Selling price per unit (a) ÷ (b) ................... $44

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32 Managerial Accounting, 16th edition

Exercise 2-12 (continued)

5. Possible critiques of Moody’s pricing tactics include (1) relying on a plantwide overhead rate to allocate overhead costs to jobs may distort the cost base used for cost-plus pricing, (2) relying on an absorption ap-proach may allocate unused capacity costs to jobs thereby distorting the cost base for cost-plus pricing, and (3) relying on absorption cost-plus pricing ignores the customers’ willingness to pay based on their per-ceived value of the product or service.

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Solutions Manual, Chapter 2 33

Exercise 2-13 (20 minutes)

1. Cutting Department:

The estimated total manufacturing overhead cost in the Cutting Depart-ment is computed as follows:

Y = $264,000 + ($2.00 per MH)(48,000 MHs)

Estimated fixed manufacturing overhead .................. $264,000Estimated variable manufacturing overhead

$2.00 per MH × 48,000 MHs ................................. 96,000Estimated total manufacturing overhead cost............ $360,000

The predetermined overhead rate is computed as follows:

Estimated total manufacturing overhead (a) . $360,000Estimated total machine-hours (b) ............... 48,000 MHsPredetermined overhead rate (a) ÷ (b)......... $7.50 per MH

Finishing Department:

The estimated total manufacturing overhead cost in the Finishing De-partment is computed as follows:

Y = $366,000 + ($4.00 per DLH)(30,000 DLHs)

Estimated fixed manufacturing overhead .................. $366,000Estimated variable manufacturing overhead

$4.00 per DLH × 30,000 DLHs .............................. 120,000Estimated total manufacturing overhead cost............ $486,000

The predetermined overhead rate is computed as follows:

Estimated total manufacturing overhead (a) .. $486,000Estimated total direct labor-hours (b) ............ 30,000 DLHsPredetermined overhead rate (a) ÷ (b).......... $16.20 per DLH

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34 Managerial Accounting, 16th edition

Exercise 2-13 (continued)

2. Total manufacturing cost assigned to Job 203:Direct materials ($500 + $310)......................... $ 810Direct labor ($108 + $360)............................... 468Cutting Department (80 MHs × $7.50 per MH) .. $600Finishing Department (20 DLH × $16.20 per

DLH) ............................................................ 324 924Total manufacturing cost.................................. $2,202

3. Yes; if some jobs require a large amount of machine time and a small amount of labor time, they would be charged substantially less overhead cost if a plantwide overhead rate based on direct labor hours were used. It appears, for example, that this would be true of Job 203 which re-quired considerable machine time to complete, but required a relatively small amount of labor hours.

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Solutions Manual, Chapter 2 35

Exercise 2-14 (10 minutes)

1. The estimated total overhead cost is computed as follows:

Y = $4,800,000 + ($0.05 per DL$)($8,000,000)

Estimated fixed overhead....................................... $4,800,000Estimated variable overhead: $0.05 per DL$ ×

$8,000,000 DL$ .................................................. 400,000Estimated total overhead cost ................................ $5,200,000

The predetermined overhead rate is computed as follows:

Estimated total overhead (a)...................... $5,200,000Estimated total direct labor-dollars (b)........ 8,000,000 DL$Predetermined overhead rate (a) ÷ (b)....... $0.65 per DL$

2. Total cost assigned to You Can Say That Again:

Direct materials ....................................................... $1,259,000Direct labor ............................................................. 2,400,000Overhead applied ($0.65 per DL$ × $2,400,000)....... 1,560,000Total job cost .......................................................... $5,219,000

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36 Managerial Accounting, 16th edition

Exercise 2-15 (45 minutes)

1a. The first step is to calculate the estimated total overhead costs in Molding and Fabrication:

Molding: Using the equation Y = a + bX, the estimated total manufac-turing overhead cost would be calculated as follows:

Y = $700,000 + ($3.00 per MH)(20,000 MHs)

Estimated fixed manufacturing overhead................... $700,000Estimated variable manufacturing overhead: $3.00

per MH × 20,000 MHs ........................................... 60,000Estimated total manufacturing overhead cost ............ $760,000

Fabrication: Using the equation Y = a + bX, the estimated total manu-facturing overhead cost would be calculated as follows:

Y = $210,000 + ($1.00 per MH)(30,000 MHs)

Estimated fixed manufacturing overhead................... $210,000Estimated variable manufacturing overhead: $1.00

per MH × 30,000 MHs ........................................... 30,000Estimated total manufacturing overhead cost ............ $240,000

The second step is to combine the estimated manufacturing overhead costs in Molding and Fabrication ($760,000 + $240,000 = $1,000,000) to enable calculating the predetermined overhead rate as follows:

Estimated total manufacturing overhead (a) $1,000,000Estimated total machine-hours (b) ............. 50,000 MHsPredetermined overhead rate (a) ÷ (b) ...... $20.00 per MH

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Solutions Manual, Chapter 2 37

Exercise 2-15 (continued)

1b. Total manufacturing cost assigned to Jobs D-70 and C-200:

D-70 C-200Direct materials ......................................... $ 700,000 $ 550,000Direct labor ............................................... 360,000 400,000Manufacturing overhead applied ($20.00

per MH × 20,000 MHs; $20.00 per MH × 30,000 MHs) ........................................... 400,000 600,000

Total manufacturing cost............................ $1,460,000 $1,550,000

1c. Bid prices for Jobs D-70 and C-200:D-70 C-200

Total manufacturing cost (a) ...................... $1,460,000 $1,550,000Markup percentage (b) .............................. 150% 150%Bid price (a) × (b) ..................................... $2,190,000 $2,325,000

1d. Because the company has no beginning or ending inventories and only Jobs D-70 and C-200 were started, completed, and sold during the year, the cost of goods sold is equal to the sum of the manufac-turing costs assigned to both jobs of $3,010,000 (=$1,460,000 + $1,550,000).

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38 Managerial Accounting, 16th edition

Exercise 2-15 (continued)

2a. Molding Department:

Using the equation Y = a + bX, the estimated total manufacturing over-head cost would be depicted as follows:

Y = $700,000 + ($3.00 per MH)(20,000 MHs)

Estimated fixed manufacturing overhead................... $700,000Estimated variable manufacturing overhead: $3.00

per MH × 20,000 MHs ........................................... 60,000Estimated total manufacturing overhead cost ............ $760,000

The predetermined overhead rate is computed as follows:

Estimated total manufacturing overhead (a) . $760,000Estimated total machine-hours (b) ............... 20,000 MHsPredetermined overhead rate (a) ÷ (b) ........ $38.00 per MH

Fabrication Department:

Using the equation Y = a + bX, the estimated total manufacturing over-head cost would be depicted as follows:

Y = $210,000 + ($1.00 per MH)(30,000 MHs)

Estimated fixed manufacturing overhead................... $210,000Estimated variable manufacturing overhead: $1.00

per MH × 30,000 MHs ........................................... 30,000Estimated total manufacturing overhead cost ............ $240,000

The predetermined overhead rate is computed as follows:

Estimated total manufacturing overhead (a) . $240,000Estimated total direct labor-hours (b)........... 30,000 MHsPredetermined overhead rate (a) ÷ (b) ........ $8.00 per MH

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Solutions Manual, Chapter 2 39

Exercise 2-15 (continued)

2b. Total manufacturing costs assigned to Jobs D-70 and C-200:

D-70 C-200Direct materials................................................ $ 700,000 $ 550,000Direct labor...................................................... 360,000 400,000Molding Department (14,000 MHs × $38 per

MH; 6,000 MHs × $38 per MH) ....................... 532,000 228,000 Fabrication Department (6,000 MH × $8 per

MH; 24,000 MH × $8 per MH) ........................ 48,000 192,000 Total manufacturing cost .................................. $1,640,000 $1,370,000

2c. Bid prices for Jobs D-70 and C-200: D-70 C-200

Total manufacturing cost (a) ....................... $1,640,000 $1,370,000Markup percentage (b) ............................... 150% 150%Bid price (a) × (b) ...................................... $2,460,000 $2,055,000

2d. Because the company has no beginning or ending inventories and only Jobs D-70 and C-200 were started, completed, and sold during the year, the cost of goods sold is equal to the sum of the manufac-turing costs assigned to both jobs of $3,010,000 (=$1,640,000 + $1,370,000).

3. The plantwide and departmental approaches for applying manufacturing overhead costs to products produce identical cost of goods sold figures. However, these two approaches lead to different bid prices for Jobs D-70 and C-200. The bid price for Job D-70 using the departmental ap-proach is $270,000 (=$2,460,000 ‒ $2,190,000) higher than the bid price using the plantwide approach. This is because the departmental cost pools reflect the fact that Job D-70 is an intensive user of Molding machine-hours. The overhead rate in Molding ($38) is much higher than the overhead rate in Fabrication ($8). Conversely, Job C-200 is an inten-sive user of the less-expensive Fabrication machine-hours, so its depart-mental bid price is $270,000 lower than the plantwide bid price.

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40 Managerial Accounting, 16th Edition

Exercise 2-15 (continued)

Whether a job-order costing system relies on plantwide overhead cost allo-cation or departmental overhead cost allocation does not usually have an important impact on the accuracy of the cost of goods sold reported for the company as a whole. However, it can have a huge impact on internal deci-sions with respect to individual jobs, such as establishing bid prices for those jobs. Job-order costing systems that rely on plantwide overhead cost allocation are commonly used to value ending inventories and cost of goods sold for external reporting purposes, but they can create costing in-accuracies for individual jobs that adversely influence internal decision making.

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Solutions Manual, Chapter 2 41

Problem 2-16 (30 minutes)

1a. The estimated total overhead cost is computed as follows:

Y = $784,000 + ($2.00 per DLH)(140,000 DLHs)

Estimated fixed manufacturing overhead................. $ 784,000Estimated variable manufacturing overhead: $2.00

per DLH × 140,000 DLH ...................................... 280,000Estimated total manufacturing overhead cost .......... $1,064,000

The predetermined overhead rate is computed as follows:

Estimated total manufacturing overhead (a) $1,064,000Estimated total direct labor-hours (b) ......... 140,000 DLHPredetermined overhead rate (a) ÷ (b)....... $7.60 per DLH

1b. Total manufacturing cost assigned to Job 550:

Direct materials ....................................................... $175Direct labor ............................................................. 225Manufacturing overhead applied ($7.60 per DLH ×

15 DLH) ............................................................... 114Total manufacturing cost of Job 550 ......................... $514

1c. The selling price for Job 550 is computed as follows: Job 550

Total manufacturing cost.......................................... $ 514Markup (200%)....................................................... 1,028Selling price ............................................................ $1,542

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42 Managerial Accounting, 16th Edition

Problem 2-16 (continued)

2a. The estimated total overhead cost is computed as follows:

Y = $784,000 + ($4.00 per MH)(70,000 MHs)

Estimated fixed manufacturing overhead................. $ 784,000Estimated variable manufacturing overhead: $4.00

per MH × 70,000 MHs ......................................... 280,000Estimated total manufacturing overhead cost .......... $1,064,000

The predetermined overhead rate is computed as follows:

Estimated total manufacturing overhead (a) . $1,064,000Estimated total machine-hours (b)................ 70,000 MHsPredetermined overhead rate (a) ÷ (b)......... $15.20 per MH

2b. Total manufacturing cost assigned to Job 550:

Direct materials ....................................................... $175Direct labor ............................................................. 225Manufacturing overhead applied ($15.20 per MH × 5

MH) ..................................................................... 76Total manufacturing cost of Job 550 ......................... $476

2c. The selling price for Job 550 is computed as follows: Job 550

Total manufacturing cost.......................................... $ 476Markup (200%)....................................................... 952Selling price ............................................................ $1,428

3. The price for Job 550 using direct labor-hours as the allocation base ($1,542) is $114 higher than the price derived using machine-hours as the allocation base ($1,428). If machine-hours is the better choice for an allocation base, then if Landen continues to use direct labor-hours as its overhead allocation base, it will overprice jobs that are intensive us-ers of direct labor-hours and non-intensive users of machine-hours. In a bidding situation, Landen will tend to lose bids on jobs such as Job 550 if its competitors have more accurate cost accounting systems.

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Solutions Manual, Chapter 2 43

Problem 2-17 (20 minutes)

1. The predetermined plantwide overhead rate is computed as follows:

Estimated manufacturing overhead (a) ....... $1,400,000Estimated total direct labor-hours (b) ......... 80,000 DLHsPredetermined overhead rate (a) ÷ (b)....... $17.50 per DLH

The overhead applied to Job Bravo is computed as follows:

Direct labor-hours worked on Bravo (a) ...... 14Predetermined overhead rate (b) ............... $17.50 per DLHOverhead applied to Bravo (a) × (b) .......... $245

2. The predetermined overhead rate in Assembly is computed as follows:

Estimated manufacturing overhead (a) ....... $600,000Estimated total direct labor-hours (b) ......... 50,000 DLHsPredetermined overhead rate (a) ÷ (b)....... $12.00 per DLH

The predetermined overhead rate in Fabrication is computed as follows:

Estimated manufacturing overhead (a) ....... $800,000Estimated total machine-hours (b) ............. 100,000 MHsPredetermined overhead rate (a) ÷ (b)....... $8.00 per MH

The overhead applied to Job Bravo is computed as follows:

Assembly Fabrication TotalQuantity of allocation base used (a) 11 6Predetermined overhead rate (b) .... $12.00 $8.00Overhead applied to Bravo (a) × (b) $132 $48 $180

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44 Managerial Accounting, 16th Edition

Problem 2-18 (15 minutes)

1. The estimated total overhead cost is computed as follows:

Y = $350,000 + ($1.00 per DLH)(20,000 DLHs)

Estimated fixed overhead....................................... $350,000Estimated variable overhead: $1.00 per DLH ×

20,000 DLHs ....................................................... 20,000Estimated total overhead cost ................................ $370,000

The predetermined overhead rate is computed as follows:

Estimated total overhead (a)........................ $370,000Estimated total direct labor-hours (b) ........... 20,000 DLHsPredetermined overhead rate (a) ÷ (b)......... $18.50 per DLH

2. Total manufacturing cost assigned to Mr. Wilkes:

Direct materials ....................................................... $590Direct labor ............................................................. 109Overhead applied ($18.50 per DLH × 6 DLH) ............ 111Total cost assigned to Mr. Wilkes .............................. $810

3. The price charged to Mr. Wilkes is computed as follows: Job 550

Total manufacturing cost.......................................... $ 810Markup (40%)......................................................... 324Selling price ............................................................ $1,134

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Solutions Manual, Chapter 2 45

Problem 2-19 (20 minutes)

1. Molding Department:

The estimated total manufacturing overhead cost in the Molding Depart-ment is computed as follows:

Y = $497,000 + $1.50 per MH × 70,000 MHs

Estimated fixed manufacturing overhead .................. $497,000Estimated variable manufacturing overhead:

$1.50 per MH × 70,000 MHs ................................. 105,000Estimated total manufacturing overhead cost............ $602,000

The predetermined overhead rate is computed as follows:

Estimated total manufacturing overhead (a) . $602,000Estimated total machine-hours (b) ............... 70,000 MHsPredetermined overhead rate (a) ÷ (b) ........ $8.60 per MH

Painting Department:

The estimated total manufacturing overhead cost in the Painting Depart-ment is computed as follows:

Y = $615,000 + $2.00 per DLH × 60,000 DLHs

Estimated fixed manufacturing overhead .................. $615,000Estimated variable manufacturing overhead:

$2.00 per DLH × 60,000 DLHs .............................. 120,000Estimated total manufacturing overhead cost............ $735,000

The predetermined overhead rate is computed as follows:

Estimated total manufacturing overhead (a) . $735,000Estimated total DLHs (b) ............................. 60,000 DLHsPredetermined overhead rate (a) ÷ (b) ........ $12.25 per DLH

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46 Managerial Accounting, 16th Edition

Problem 2-19 (continued)

2. Molding Department overhead applied: 110 machine-hours × $8.60 per machine-hour $ 946

Painting Department overhead applied: 84 direct labor-hours × $12.25 per DLH .......... 1,029

Total overhead cost............................................. $1,975

3. Total cost of Job 205:

Molding Dept.

PaintingDept. Total

Direct materials.......................... $ 770 $1,332 $2,102Direct labor................................ 525 1,470 1,995Manufacturing overhead applied.. 946 1,029 1,975Total manufacturing cost ............ $2,241 $3,831 $6,072

Unit product cost for Job 205: Total manufacturing cost (a)...................... $6,072Number of units in the job (b).................... 50 unitsUnit product cost (a) ÷ (b) ........................ $121.44 per unit

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Solutions Manual, Chapter 2 47

Problem 2-20 (45 minutes)

1a. The first step is to calculate the total estimated overhead costs in ICU and Other:

ICU: Using the equation Y = a + bX, the estimated total overhead cost would be calculated as follows:

Y = $3,200,000 + ($236 per patient-day)(2,000 patient-days)

Estimated fixed overhead.................................... $3,200,000Estimated variable overhead:

$236 per patient-day × 2,000 patient-days ........ 472,000Estimated total overhead cost ............................. $3.672,000

Other: Using the equation Y = a + bX, the estimated total overhead cost would be calculated as follows:

Y = $14,000,000 + ($96 per patient-day)(18,000 patient-days)

Estimated fixed overhead .................................... $14,000,000Estimated variable overhead:

$96 per patient-day × 18,000 patient-days ........ 1,728,000Estimated total overhead cost .............................. $15.728,000

The second step is to combine the estimated overhead costs in ICU and Other ($3,672,000 + $15,728,000 = $19,400,000) to enable calculating the predetermined overhead rate as follows:

Estimated total overhead (a)............... $19,400,000Estimated total patient-days (b) .......... 20,000 patient-daysPredetermined overhead rate (a) ÷ (b) $970 per patient-day

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48 Managerial Accounting, 16th Edition

Problem 2-20 (continued)

1b. The total cost assign to Patients A and B is computed as follows:

Patient A Patient BDirect materials...................................... $ 4,500 $ 6,200Direct labor............................................ 25,000 36,000Overhead applied ($970 per patient-day

× 14 patient days; ($970 per patient-day × 21 patient days) ........................ 13,580 20,370

Total cost .............................................. $43,080 $62,570

2a. The overhead rate in ICU is computed as follows:

Y = $3,200,000 + ($236 per patient-day)(2,000 patient-days)

Estimated fixed overhead.................................... $3,200,000Estimated variable overhead:

$236 per patient-day × 2,000 patient-days ........ 472,000Estimated total overhead cost ............................. $3,672,000

The predetermined overhead rate is computed as follows:

Estimated total overhead (a) ............... $3,672,000Estimated total patient-days (b)........... 2,000 patient-daysPredetermined overhead rate (a) ÷ (b) $1,836 per patient-day

The overhead rate in Other is computed as follows:

Y = $14,000,000 + ($96 per patient-day)(18,000 patient-days)

Estimated fixed overhead .................................... $14,000,000Estimated variable overhead:

$96 per patient-day × 18,000 patient-days ........ 1,728,000Estimated total overhead cost .............................. $15,728,000

The predetermined overhead rate is computed as follows:

Estimated total overhead (a) ............... $15,728,000Estimated total patient-days (b)........... 18,000 patient-daysPredetermined overhead rate

(rounded) (a) ÷ (b) .......................... $873.78 per patient-day

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Solutions Manual, Chapter 2 49

Problem 2-20 (continued)

2b.The total cost assigned to Patient A:

Direct materials................................................ $ 4,500Direct labor...................................................... 25,000ICU ($1,836 per patient-day × 0 patient-days)... $ 0Other ($873.78 per patient day × 14 patient-

days) (rounded to nearest dollar) ................... 12,233 12,233Total cost assigned to Patient A ........................ $41,733

The total cost assigned to Patient B:

Direct materials................................................ $ 6,200Direct labor...................................................... 36,000ICU ($1,836 per patient-day × 7 patient-days)... $12,852Other ($873.78 per patient day × 14 patient-

days) (rounded to nearest dollar) ................... 12,233 25,085Total cost assigned to Patient B ........................ $67,285

3. Relying on just one predetermined overhead rates overlooks the fact that some departments are more intensive users of overhead resources than others. As the name implies, patients in the ICU require more in-tensive (and expensive) care than other patients in other departments. Broadly, speaking, relying on only one overhead rate, will most likely overcost patients with less severe illnesses and undercost patients with more severe illnesses.

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50 Managerial Accounting, 16th Edition

Problem 2-21 (30 minutes)

1. The plantwide predetermined overhead rate is computed as follows:

Estimated manufacturing overhead (a) ....... $600,000Estimated total direct labor-hours (b) ......... 60,000 DLHsPredetermined overhead rate (a) ÷ (b)....... $10 per DLH

The overhead applied to Job A is computed as follows:

Direct labor-hours worked on Job A (a) ...... 15Predetermined overhead rate (b) ............... $10 per DLHOverhead applied to Job A (a) × (b)........... $150

The overhead applied to Job B is computed as follows:

Direct labor-hours worked on Job B (a) ...... 9Predetermined overhead rate (b) ............... $10 per DLHOverhead applied to Job B (a) × (b)........... $90

2. The predetermined overhead rate in Machining is computed as follows:

Estimated manufacturing overhead (a) ....... $500,000Estimated total machine-hours (b) ............. 50,000 MHsPredetermined overhead rate (a) ÷ (b)....... $10 per MH

The predetermined overhead rate in Assembly is computed as follows:

Estimated manufacturing overhead (a) ....... $100,000Estimated total direct labor-hours (b) ......... 50,000 DLHsPredetermined overhead rate (a) ÷ (b)....... $2 per DLH

The overhead applied to Job A is computed as follows:

Machining Assembly TotalQuantity of allocation base used (a) . 11 10Predetermined overhead rate (b) ..... $10 $2Overhead applied to Job A (a) × (b). $110 $20 $130

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Solutions Manual, Chapter 2 51

Problem 2-21 (continued)

The overhead applied to Job B is computed as follows:

Machining Assembly TotalQuantity of allocation base used (a) . 12 5Predetermined overhead rate (b) ..... $10 $2Overhead applied to Job B (a) × (b). $120 $10 $130

3. The plantwide approach will overcost jobs that are intensive users of As-sembly and minimal users of Machining. Conversely, it will undercost products that are intensive users of Machining and minimal users of As-sembly. These cost distortions will adversely impact the company’s pric-ing process. Jobs that get overcosted will have selling prices that are greater than the prices that would be established using departmental overhead allocation. Jobs that get undercosted will have selling prices that are less than the prices that would be established using depart-mental overhead allocation.

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52 Managerial Accounting, 16th Edition

Case 2-22 (60 minutes)

1. a.Estimated total manufacturing overhead costPredetermined =

overhead rate Estimated total amount of the allocation base

$840,000 140% of direct= = labor cost$600,000 direct labor cost

b. The manufacturing overhead cost applied to the Koopers job is com-puted as follows:

$9,500 × 140% = $13,300

2. a.Fabricating Department

Machining Department

Assembly Department

Estimated manufacturing overhead cost (a) ......... $350,000 $400,000 $ 90,000

Estimated direct labor cost (b)........................ $200,000 $100,000 $300,000

Predetermined overhead rate (a) ÷ (b) ............... 175% 400% 30%

b. Fabricating Department:$2,800 × 175%............................. $4,900

Machining Department:$500 × 400% ............................... 2,000

Assembly Department:$6,200 × 30% .............................. 1,860

Total applied overhead..................... $8,760

3. The bulk of the labor cost on the Koopers job is in the Assembly Depart-ment, which incurs very little overhead cost. The department has an overhead rate of only 30% of direct labor cost as compared to much higher rates in the other two departments. Therefore, as shown above, use of departmental overhead rates results in a relatively small amount of overhead cost being charged to the job.

Use of a plantwide overhead rate in effect redistributes overhead costs proportionately between the three departments (at 140% of direct labor

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Solutions Manual, Chapter 2 53

Case 2-22 (continued)

cost) and results in a large amount of overhead cost being charged to the Koopers job, as shown in Part 1. This may explain why the company

bid too high and lost the job. Too much overhead cost was assigned to the job for the kind of work being done on the job in the plant.

On jobs that require a large amount of labor in the Fabricating or Ma-chining Departments the opposite will be true, and the company will tend to charge too little overhead cost to the jobs if a plantwide over-head rate is being used. The reason is that the plantwide overhead rate (140%) is much lower than the rates would be if these departments were considered separately.

4. The company’s bid was:

Direct materials........................................... $ 4,600Direct labor................................................. 9,500Manufacturing overhead applied (see require-

ment 1b) .................................................. 13,300Total manufacturing cost ............................. $27,400Bidding rate ................................................ × 1.5Total bid price............................................. $41,100

If departmental overhead rates had been used, the bid would have been:

Direct materials........................................... $ 4,600Direct labor................................................. 9,500Manufacturing overhead applied (see require-

ment 2b) .................................................. 8,760Total manufacturing cost ............................. $22,860Bidding rate ................................................ × 1.5Total bid price............................................. $34,290

Note that if departmental overhead rates had been used, Teledex Com-pany would have been the low bidder on the Koopers job because the competitor underbid Teledex by only $2,000.

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54 Managerial Accounting, 16th Edition

Appendix 2A Activity-Based Absorption Costing

Exercise 2A-1 (20 minutes)

1. Activity rates are computed as follows:

Activity Cost Pool

(a) Estimated Overhead

Cost

(b) Expected Activity

(a) ÷ (b) Activity Rate

Machine setups...... $72,000 400 setups $180 per setupSpecial processing.. $200,000 5,000 MHs $40 per MHGeneral factory ...... $816,000 24,000 DLHs $34 per DLH

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Solutions Manual, Appendix 2A 55

Exercise 2A-1 (continued)

2. Overhead is assigned to the two products as follows:

Hubs:

Activity Cost Pool (a)

Activity Rate (b)

Activity (a) × (b) ABC Cost

Machine setups ..................... $180 per setup 100 setups $ 18,000Special processing ................. $40 per MH 5,000 MHs 200,000General factory ..................... $34 per DLH 8,000 DLHs 272,000Total..................................... $490,000

Sprockets:

Activity Cost Pool (a)

Activity Rate (b)

Activity (a) × (b) ABC Cost

Machine setups ..................... $180 per setup 300 setups $ 54,000Special processing ................. $40 per MH 0 MHs 0General factory ..................... $34 per DLH 16,000 DLHs 544,000Total..................................... $598,000

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56 Managerial Accounting, 16th Edition

Exercise 2A-1 (continued)

2. Each product’s unit product cost is computed as follows:

Hubs Sprockets Direct materials................................... $32.00 $18.00Direct labor:

$15 per DLH × 0.80 DLHs per unit .... 12.00$15 per DLH × 0.40 DLHs per unit .... 6.00

Overhead:$490,000 ÷ 10,000 units................... 49.00$598,000 ÷ 40,000 units................... 14.95

Unit product cost ................................ $93.00 $38.95

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Solutions Manual, Appendix 2A 57

Exercise 2A-2 (45 minutes)

1. The unit product costs under the company's traditional costing system would be computed as follows:

Rascon Parcel Total Number of units produced (a) ...................... 20,000 80,000Direct labor-hours per unit (b)...................... 0.40 0.20Total direct labor-hours (a) × (b) ................. 8,000 16,000 24,000

Total manufacturing overhead (a) ................ $576,000Total direct labor-hours (b) .......................... 24,000 DLHsPredetermined overhead rate (a) ÷ (b)......... $24.00 per DLH

Rascon Parcel Direct materials........................................... $13.00 $22.00Direct labor................................................. 6.00 3.00Manufacturing overhead applied:

0.40 DLH per unit × $24.00 per DLH.......... 9.600.20 DLH per unit × $24.00 per DLH.......... 4.80

Unit product cost......................................... $28.60 $29.80

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58 Managerial Accounting, 16th Edition

Exercise 2A-2 (continued)

2. The unit product costs using activity-based absorption costing can be computed as follows:

Activity Cost Pool

Estimated Overhead

Cost* (b)

Expected Activity (a) ÷ (b)

Activity Rate Labor related ........... $288,000 24,000 direct labor-hours $12.00 per direct labor-hourEngineering design... $288,000 6,000 engineering-hours $48.00 per engineering-hour

$576,000

*The total estimated manufacturing overhead cost of $576,000 is split evenly between the two activ-ity cost pools.

Manufacturing overhead is assigned to the two products as follows:

Rascon:

Activity Cost Pool (a)

Activity Rate (b)

Activity (a) × (b) ABC Cost

Labor related ......... $12 per DLH 8,000 DLHs $ 96,000Engineering design . $48 per engineering-hour 3,000 engineering-hours 144,000Total...................... $240,000

Parcel:

Activity Cost Pool (a)

Activity Rate (b)

Activity (a) × (b) ABC Cost

Labor related ......... $12 per DLH 16,000 DLHs $192,000Engineering design . $48 per engineering-hour 3,000 engineering-hours 144,000Total...................... $336,000

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Solutions Manual, Appendix 2A 59

Exercise 2A-2 (continued)

The unit product costs combine direct materials, direct labor, and over-head costs:

Rascon Parcel Direct materials............................................. $13.00 $22.00Direct labor................................................... 6.00 3.00Manufacturing overhead ($240,000 ÷ 20,000

units; $336,000 ÷ 80,000 units) .................. 12.00 4.20 Unit product cost........................................... $31.00 $29.20

3. The unit product cost of the high-volume product, Parcel, declines under the activity-based approach, whereas the unit product cost of the low-volume product, Rascon, increases. This occurs because half of the overhead is applied on the basis of engineering design hours instead of direct labor-hours. When the overhead was applied on the basis of di-rect labor-hours, most of the overhead was applied to the high-volume product. However, when the overhead is applied on the basis of engi-neering-hours, more of the overhead cost is shifted over to the low-vol-ume product. Engineering-hours is a product-level activity, so the higher the volume, the lower the unit cost and the lower the volume, the higher the unit cost.

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60 Managerial Accounting, 16th Edition

Exercise 2A-3 (45 minutes)

1. The predetermined overhead rate is computed as follows:

$325,000Predetermined = = $6.50 per DLHoverhead rate 50,000 DLHs

The unit product costs under the company’s traditional costing system are computed as follows:

Deluxe Stand-ard

Direct materials....................................................... $72.00 $53.00Direct labor............................................................. 19.00 15.20Manufacturing overhead (1.0 DLH × $6.50 per DLH;

0.8 DLH × $6.50 per DLH) .................................... 6.50 5.20Unit product cost..................................................... $97.50 $73.40

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Solutions Manual, Appendix 2A 61

Exercise 2A-3 (continued)

2. The activity rates are computed as follows:

(a)Estimated (b)Overhead Total (a) ÷ (b)

Activity Cost Pool Cost Expected Activity Activity RateSupporting direct labor... $200,000 50,000 DLHs $4 per DLHBatch setups ................. $75,000 300 setups $250 per setupSafety testing ................ $50,000 100 tests $500 per test

Manufacturing overhead is assigned to the two products as follows:

Deluxe Product:

Activity Cost Pool (a)

Activity Rate (b)

Activity (a) × (b) ABC Cost

Supporting direct labor .......... $4 per DLH 10,000 DLHs $ 40,000Batch setups ......................... $250 per setup 200 setups 50,000Safety testing........................ $500 per test 30 tests 15,000Total..................................... $105,000

Standard Product:

Activity Cost Pool (a)

Activity Rate (b)

Activity (a) × (b) ABC Cost

Supporting direct labor .......... $4 per DLH 40,000 DLHs $160,000Batch setups ......................... $250 per setup 100 setups 25,000Safety testing........................ $500 per test 70 tests 35,000Total..................................... $220,000

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62 Managerial Accounting, 16th Edition

Exercise 2A-3 (continued)

Activity-based absorption costing unit product costs are computed as follows:

Deluxe StandardDirect materials .................................................. $ 72.00 $53.00Direct labor ........................................................ 19.00 15.20Manufacturing overhead ($105,000 ÷ 10,000

units; $220,000 ÷ 50,000 units) ....................... 10.50 4.40Unit product cost ................................................ $101.50 $72.60

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Solutions Manual, Appendix 2A 63

Problem 2A-4 (60 minutes)

1. a. When direct labor-hours are used to apply overhead cost to products, the company’s predetermined overhead rate would be:

Manufacturing overhead costPredetermined = overhead rate Direct labor-hours

$1,800,000= = $50 per DLH

36,000DLHs

b. Model

X200 X99 Direct materials.......................................... $ 72 $ 50Direct labor:

$20 per hour × 1.8 hours and 0.9 hours ... 36 18Manufacturing overhead:

$50 per hour × 1.8 hours and 0.9 hours ... 90 45Total unit product cost................................ $198 $113

2. a. Predetermined overhead rates for the activity cost pools:

Activity Cost Pool

(a) Estimated Total Cost

(b) Estimated

Total Activity (a) ÷ (b)

Activity Rate Machine setups...... $360,000 150 setups $2,400 per setupSpecial processing . $180,000 12,000 MHs $15 per MHGeneral factory...... $1,260,000 36,000 DLHs $35 per DLH

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64 Managerial Accounting, 16th Edition

Problem 2A-4 (continued)

The overhead applied to each product can be determined as follows:

Model X200

Activity Cost Pool (a)

Activity Rate (b)

Activity (a) × (b) ABC Cost

Machine setups .................................... $2,400 per setup 50 setups $120,000Special processing................................ $15 per MH 12,000 MHs 180,000General factory .................................. $35 per DLH 9,000 DLHs 315,000Total manufacturing overhead cost (a) $615,000Number of units produced (b)............. 5,000Overhead cost per unit (a) ÷ (b)......... $123.00

Model X99

Activity Cost Pool (a)

Activity Rate (b)

Activity (a) × (b) ABC Cost

Machine setups .................................... $2,400 per setup 100 setups $ 240,000Special processing................................ $15 per MH 0 MHs 0General factory .................................. $35 per DLH 27,000 DLHs 945,000Total manufacturing overhead cost (a) $1,185,000Number of units produced (b)............. 30,000Overhead cost per unit (a) ÷ (b)......... $39.50

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Solutions Manual, Appendix 2A 65

Problem 2A-4 (continued)

b. The unit product cost of each model under the activity-based ap-proach would be computed as follows:

Model

X200 X99 Direct materials ..................................... $ 72.00 $50.00Direct labor:

$20 per DLH × 1.8 DLHs, 0.9 DLHs ...... 36.00 18.00Manufacturing overhead (above) ............ 123.00 39.50Total unit product cost ........................... $231.00 $107.50

Comparing these unit cost figures with the unit costs in Part 1(b), we find that the unit product cost for Model X200 has increased from $198 to $231, and the unit product cost for Model X99 has decreased from $113 to $107.50.

3. It is especially important to note that, even under activity-based costing, 70% of the company’s overhead costs continue to be applied to prod-ucts on the basis of direct labor-hours:

Machine setups (number of setups)... $ 360,000 20%Special processing (machine-hours)... 180,000 10General factory (direct labor-hours)... 1,260,000 70Total overhead cost.......................... $1,800,000 100%

Thus, the shift in overhead cost from the high-volume product (Model X99) to the low-volume product (Model X200) occurred as a result of re-assigning only 30% (=20% + 10%) of the company’s overhead costs.

The increase in unit product cost for Model X200 can be explained as follows: First, where possible, overhead costs have been traced to the products rather than being lumped together and spread uniformly over production. Therefore, the special processing costs, which are traceable to Model X200, have all been assigned to Model X200 and none as-signed to Model X99 under the activity-based approach. It is common in industry to have some products that require special handling or special processing of some type. This is especially true in modern factories that produce a variety of products. Activity-based costing provides a vehicle for assigning these costs to the appropriate products.

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66 Managerial Accounting, 16th Edition

Problem 2A-4 (continued)

Second, the costs associated with the batch-level activity (machine set-ups) have also been assigned to the specific products to which they re-late. These costs have been assigned according to the number of setups completed for each product. However, because a batch-level activity is involved, another factor affecting unit costs comes into play. That factor is batch size. Some products are produced in large batches and some are produced in small batches. The smaller the batch, the higher the per unit cost of the batch activity. In the case at hand, the data can be ana-lyzed as follows:

Model X200:Cost to complete one setup (see requirement 2a)........ $2,400 (a)Number of units processed per setup

(5,000 units per setup ÷ 50 setups = 100 units) ....... 100 units (b)

Setup cost per unit (a) ÷ (b) ...................................... $24

Model X99:Cost to complete one setup (see requirement 2a)........ $2,400 (a)Number of units processed per setup

(30,000 units per setup ÷ 100 setups = 300 units) ... 300 units (b)Setup cost per unit (a) ÷ (b) ...................................... $8

Thus, the cost per unit for setups is three times as great for Model X200, the low-volume product, as it is for Model X99, the high-volume product. Such differences in cost are obscured when direct labor-hours (or any other volume measure) is used as a basis for applying overhead cost to products.

In sum, overhead cost has shifted from the high-volume product to the low-volume product as a result of more appropriately assigning some costs to the products on the basis of the activities involved, rather than on the basis of direct labor-hours.

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Solutions Manual, Appendix 2A 67

Problem 2A-5 (60 minutes)

1. The company’s estimated direct labor-hours can be computed as fol-lows:

Deluxe model: 5,000 units × 2 DLHs per unit .... 10,000 DLHsRegular model: 40,000 units × 1 DLH per unit... 40,000 DLHsTotal direct labor hours .................................... 50,000 DLHs

Using just direct labor-hours as the base, the predetermined overhead rate would be:

Estimated overhead cost $900,000 = = $18 per DLH

Estimated direct labor-hours 50,000DLHs

The unit product cost of each model using the company’s traditional costing system would be:

Deluxe RegularDirect materials...................... $ 40 $25Direct labor............................ 38 19Manufacturing overhead:

$18 per DLH × 2 DLHs......... 36$18 per DLH × 1 DLH .......... 18

Total unit product cost ........... $114 $62

2. Predetermined overhead rates are computed below:

Activity Cost Pool

(a) Estimated Overhead

Cost

(b) Expected Activity

(a) ÷ (b) Activity Rate

Purchasing................ $204,000 600 purchase or-ders

$340 per purchase order

Processing ................ $182,000 35,000 machine-hours

$5.20 per machine-hour

Scrap/rework ............ $379,000 2,000 orders $189.50 per orderShipping ................... $135,000 900 shipments $150 per shipment

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68 Managerial Accounting, 16th Edition

Problem 2A-5 (continued)

3. a. The overhead applied to each product can be determined as follows:

The Deluxe Model

Activity Cost Pool (a)

Activity Rate (b)

Activity (a) × (b) ABC Cost

Purchasing................................. $340 per PO 200 POs $ 68,000Processing ................................. $5.20 per MH 20,000 MHs 104,000Scrap/rework ............................. $189.50 per order 1,000 tests 189,500Shipping .................................... $150 per shipment 250 shipments 37,500Total overhead cost (a) .............. $399,000Number of units produced (b)..... 5,000Overhead cost per unit (a) ÷ (b). $79.80

The Regular Model

Activity Cost Pool (a)

Activity Rate (b)

Activity (a) × (b) ABC Cost

Purchasing................................. $340 per PO 400 POs $136,000Processing ................................. $5.20 per MH 15,000 MHs 78,000Scrap/rework ............................. $189.50 per order 1,000 orders 189,500Shipping .................................... $150 per shipment 650 shipments 97,500Total overhead cost (a) .............. $501,000Number of units produced (b)..... 40,000Overhead cost per unit (a) ÷ (b). $12.53

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Solutions Manual, Appendix 2A 69

Problem 2A-5 (continued)

b. Using activity-based absorption costing, the unit product cost of each model would be:

Deluxe Regular Direct materials.......................... $ 40.00 $25.00Direct labor................................ 38.00 19.00Manufacturing overhead (above). 79.80 12.53Total unit product cost................ $157.80 $56.53

4. Unit costs appear to be distorted as a result of using direct labor-hours as the base for assigning overhead cost to products. Although the deluxe model requires twice as much labor time as the regular model, it still is not being assigned enough overhead cost, as shown in the analy-sis in part 3(a).

When the company’s overhead costs are analyzed on an activities basis, it appears that the deluxe model is more expensive to manufacture than the company realizes. Note that the deluxe model accounts for a major-ity of the machine-hours worked, even though it accounts for only 20% (= 10,000 DLHs ÷ 50,000 DLHs) of the company’s direct labor-hours. Also, it requires just as many scrap/rework orders as the regular model, and scrap/rework orders are very costly to the company.

When activity-based absorption costing is used and the company’s transactions are analyzed by product, the overhead cost increases for the deluxe model from $36.00 per unit to $79.80 per unit. This suggests that less than half the overhead cost is being assigned to the deluxe model that ought to be assigned, and unit costs for the deluxe model are understated. If these costs are being used as a basis for pricing, then the selling price for the deluxe model may be too low. This may be the reason why profits have been steadily declining over the last several years. It may also be the reason why sales of the deluxe model have been increasing rapidly.

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70 Managerial Accounting, 16th Edition

Case 2A-6 (90 minutes)

1. a. The predetermined overhead rate would be computed as follows:

Expected manufacturing overhead cost $2,200,000 =

Estimated direct labor-hours 50,000 DLHs

= $44 per DLH

b. The unit product cost per pound, using the company’s present costing system, would be:

Kenya Dark

Viet Select

Direct materials (given) ......... $4.50 $2.90Direct labor (given) ............... 0.34 0.34Manufacturing overhead:

0.02 DLH × $44 per DLH ..... 0.88 0.88 Total unit product cost........... $5.72 $4.12

2. a. Overhead rates for each activity cost pool:

Activity Cost Pools

(a) Estimated Overhead

Costs

(b) Expected Activity

(a) ÷ (b) Activity Rate

Purchasing ........... $560,000 2,000 orders $280 per orderMaterial handling .. $193,000 1,000 setups $193 per setupQuality control ...... $90,000 500 batches $180 per batchRoasting............... $1,045,000 95,000 hours $11 per hour Blending............... $192,000 32,000 hours $6 per hour Packaging ............ $120,000 24,000 hours $5 per hour

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Solutions Manual, Appendix 2A 71

Case 2A-6 (continued)

Before we can determine the amount of overhead cost to assign to the products we must first determine the activity for each of the products in the six activity centers. The necessary computations fol-low:

Number of purchase orders:Kenya Dark: 80,000 pounds ÷ 20,000 pounds per order = 4 ordersViet Select: 4,000 pounds ÷ 500 pounds per order = 8 orders

Number of setups:Kenya Dark: (80,000 pounds ÷ 5,000 pounds per batch) × 2 setups

per batch = 32 setups Viet Select: (4,000 pounds ÷ 500 pounds per batch) × 2 setups per

batch = 16 setups Number of batches:

Kenya Dark: 80,000 pounds ÷ 5,000 pounds per batch = 16 batchesViet Select: 4,000 pounds ÷ 500 pounds per batch = 8 batches

Roasting hours:Kenya Dark: 1.5 hours × (80,000 pounds ÷ 100 pounds) = 1,200

hours Viet Select: 1.5 hours × (4,000 pounds ÷ 100 pounds) = 60 hours

Blending hours:Kenya Dark: 0.5 hour × (80,000 pounds ÷ 100 pounds) = 400 hoursViet Select: 0.5 hour × (4,000 pounds ÷ 100 pounds) = 20 hours

Packaging hours:Kenya Dark: 0.3 hour × (80,000 pounds ÷ 100 pounds) = 240 hoursViet Select: 0.3 hour × (4,000 pounds ÷ 100 pounds) = 12 hours

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72 Managerial Accounting, 16th Edition

Case 2A-6 (continued)

The overhead applied to each product can be determined as follows:

Kenya DarkActivity Cost Pool Activity Rate Expected Activity AmountPurchasing ............... $280 per order 4 orders $ 1,120Material handling ...... $193 per setup 32 setups 6,176Quality control .......... $180 per batch 16 batches 2,880Roasting................... $11 per roasting hour 1,200 roasting hours 13,200Blending................... $6 per blending hour 400 blending hours 2,400Packaging................. $5 per packaging hour 240 packaging hours 1,200Total ........................ $26,976

Viet SelectActivity Cost Pool Activity Rate Expected Activity AmountPurchasing ............... $280 per order 8 orders $2,240Material handling ...... $193 per setup 16 setups 3,088Quality control .......... $180 per batch 8 batches 1,440Roasting................... $11 per roasting hour 60 roasting hours 660Blending................... $6 per blending hour 20 blending hours 120Packaging................. $5 per packaging hour 12 packaging hours 60Total ........................ $7,608

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Solutions Manual, Appendix 2A 73

Case 2A-6 (continued)

b. According to the activity-based absorption costing system, the manu-facturing overhead cost per pound is:

Kenya Dark

Viet Select

Total overhead cost assigned (above) (a) ... $26,976 $7,608Number of pounds manufactured (b).......... 80,000 4,000Cost per pound (a) ÷ (b) ........................... $0.34 $1.90

c. The unit product costs according to the activity-based absorption costing system are:

Kenya Dark

Viet Select

Direct materials (given) ............ $4.50 $2.90Direct labor (given) .................. 0.34 0.34Manufacturing overhead ........... 0.34 1.90Total unit product cost.............. $5.18 $5.14

3. MEMO TO THE PRESIDENT: Analysis of JSI’s data shows that several activities other than direct labor drive the company’s manufacturing overhead costs. These activities include purchase orders issued, number of setups for material processing, and number of batches processed. The company’s present costing system, which relies on direct labor time as the sole basis for assigning overhead cost to products, significantly undercosts low-volume products, such as the Viet Select coffee, and sig-nificantly overcosts high-volume products, such as our Kenya Dark cof-fee.

An implication of the activity-based approach is that our low-volume products may not be covering the costs of the manufacturing resources they use. For example, Viet Select coffee is currently priced at $5.15 per pound ($4.12 plus 25% markup), which is only one cent higher than its activity-based cost of $5.14 per pound. Under our present costing and pricing system, our high-volume products, such as our Kenya Dark cof-fee, may be subsidizing our low-volume products. Some adjustments in prices may be required.

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74 Managerial Accounting, 16th Edition

Case 2A-6 (continued)

ALTERNATIVE SOLUTION:

Most students will compute the manufacturing overhead cost per pound of the two coffees as shown above. However, the per pound cost can also be computed as shown below. This alternative approach provides additional insight into the data and facilitates emphasis of some points made in the chapter.

Kenya Dark Viet Select

Total Per Pound (÷ 80,000) Total

Per Pound (÷ 4,000)

Purchasing........... $ 1,120 $0.014 $2,240 $0.560Material handling.. 6,176 0.077 3,088 0.772Quality control ..... 2,880 0.036 1,440 0.360Roasting .............. 13,200 0.165 660 0.165Blending .............. 2,400 0.030 120 0.030Packaging ............ 1,200 0.015 60 0.015Total ................... $26,976 $0.337 $7,608 $1.902

Note particularly how batch size impacts unit cost data. For example, the cost to the company to process a purchase order is $280, regardless of how many pounds of coffee are contained in the order. Twenty thousand pounds of the Kenya Dark coffee are purchased per order (with four orders per year), and just 500 pounds of the Viet Select coffee are purchased per order (with eight orders per year). Thus, the purchase order cost per pound for the Kenya Dark coffee is just 1.4 cents, whereas the purchase order cost per pound for the Viet Select coffee is 40 times as much, or 56 cents. As stated in the text, this is one reason why unit costs of low-vol-ume products, such as the Viet Select coffee, increase so dramatically when activity-based costing is used.

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Solutions Manual, Appendix 2B 75

Appendix 2B The Predetermined Overhead Rate and Capacity

Exercise 2B-1 (20 minutes)

1. There were no beginning or ending inventories, so all of the jobs were started, finished, and sold during the month. Therefore cost of goods sold equals the total manufacturing cost. We can verify that by compu-ting the cost of goods sold as shown below:

Manufacturing costs charged to jobs:Direct materials........................................... $ 5,350Direct labor (all variable).............................. 8,860Manufacturing overhead applied

(150 hours × $82 hour) ............................ 12,300 Total manufacturing cost charged to jobs ........ 26,510Add: Beginning work in process inventory ....... 0

26,510Deduct: Ending work in process inventory ....... 0Cost of goods manufactured ........................... $26,510

Beginning finished goods inventory ................. $ 0Add: Cost of goods manufactured ................... 26,510Goods available for sale.................................. 26,510Deduct: Ending finished goods inventory ......... 0Cost of goods sold ......................................... $26,510

At the end of the month, the cost of unused capacity is computed as shown below:

Amount of the allocation base at capacity (a) . 180 hoursActual amount of the allocation base (b) ........ 150 hoursUnused capacity in hours (a) – (b) ................. 30 hours

Unused capacity in hours (a) ......................... 30 hoursPredetermined overhead rate (b) ................... $82 per hourCost of unused capacity (a) × (b) .................. $2,460

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76 Managerial Accounting, 16th Edition

Exercise 2B-1 (continued)

Consequently, the income statement, prepared for internal management purposes, would appear as follows:

Wixis CabinetsIncome Statement

Sales.................................................... $43,740Cost of goods sold (see above) .............. 26,510Gross margin ........................................ 17,230Other expenses:

Cost of unused capacity...................... $2,460Selling and administrative expenses .... 8,180 10,640

Net operating income............................ $ 6,590

2. When the predetermined overhead rate is based on capacity, unused capacity costs ordinarily arise because manufacturing overhead usually contains significant amounts of fixed costs. Suppose, for example, that manufacturing overhead includes $10,000 of fixed costs and the capac-ity is 100 hours. Then the portion of the predetermined overhead rate that represents fixed costs is $10,000 divided by 100 hours or $100 per hour. Because the plant is seldom (if ever) operated beyond capacity, less than $10,000 will ordinarily be applied to jobs. In other words, $100 per hour multiplied by something less than 100 hours always yields less than $10,000. Therefore, unused capacity costs will arise.

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Solutions Manual, Appendix 2B 77

Exercise 2B-2 (30 minutes)

1. The overhead applied to Mrs. Brinksi’s account would be computed as follows:

Last Year This YearEstimated overhead cost (a) ............................. $310,500 $310,500Estimated professional staff hours (b) ............... 4,600 4,500Predetermined overhead rate (a) ÷ (b) ............. $67.50 $69.00Professional staff hours charged to Ms. Brinksi’s

account ......................................................... × 2.5 × 2.5Overhead applied to Ms. Brinksi’s account ......... $168.75 $172.50

2. If the actual overhead cost and the actual professional hours charged turn out to be exactly as estimated there would be no cost of unused capacity.

Last Year This YearPredetermined overhead rate (see above) ......... $67.50 $69.00Actual professional staff hours charged to cli-

ents’ accounts (by assumption) ...................... × 4,600 × 4,500Overhead applied............................................. $310,500 $310,500Actual overhead cost incurred (by assumption) .. 310,500 310,500Cost of unused capacity.................................... $ 0 $ 0

3. If the predetermined overhead rate is based on the professional staff hours available, the computations would be:

Last Year This YearEstimated overhead cost (a)............................... $310,500 $310,500Professional staff hours available (b) .................. 6,000 6,000Predetermined overhead rate (a) ÷ (b)............... $51.75 $51.75Professional staff hours charged to Ms. Brinksi’s

account .......................................................... × 2.5 × 2.5Overhead applied to Ms. Brinksi’s account........... $129.38 $129.38

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78 Managerial Accounting, 16th Edition

Exercise 2B-2 (continued)

4. If the actual overhead cost and the actual professional staff hours charged to clients’ accounts turn out to be exactly as estimated, the cost of unused capacity would be calculated as shown below.

Last Year This YearAmount of the allocation base at capacity (a)...... 6,000 6,000Actual amount of the allocation base (b) ............. 4,600 4,500Unused capacity in hours (a) – (b)...................... 1,400 1,500

Unused capacity in hours (a).............................. 1,400 1,500Predetermined overhead rate (b)........................ $51.75 $51.75Cost of unused capacity (a) × (b)....................... $72,450 $77,625

Proponents of this method of computing predetermined overhead rates suggest that the cost of unused capacity should be treated as a period expense that is disclosed separately on the income statement.

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Solutions Manual, Appendix 2B 79

Problem 2B-3 (60 minutes)

1. The overhead applied to the Verde Baja job is computed as follows:

Last Year

This Year

Estimated studio overhead cost (a) ................. $160,000 $160,000Estimated hours of studio service (b) .............. 1,000 800Predetermined overhead rate (a) ÷ (b) ........... $160 $200Verde Baja job’s studio hours ......................... × 40 × 40Overhead applied to the Verde Baja job ......... $6,400 $8,000

2. If the predetermined overhead rate is based on the hours of studio ser-vice at capacity, the computations would be:

Last Year This YearEstimated studio overhead cost at capacity (a) $160,000 $160,000Hours of studio service at capacity (b)............. 1,600 1,600Predetermined overhead rate (a) ÷ (b) ........... $100 $100Verde Baja job’s studio hours ......................... × 40 × 40Overhead applied to the Verde Baja job ......... $4,000 $4,000

3. The cost of unused capacity for both years is computed as follows:

Last Year This YearAmount of the allocation base at capacity (a)...... 1,600 1,600Actual amount of the allocation base (b) ............. 750 500Unused capacity in hours (a) – (b)...................... 850 1,100

Unused capacity in hours (a).............................. 850 1,100Predetermined overhead rate (b)........................ $100 $100Cost of unused capacity (a) × (b)....................... $85,000 $110,000

Proponents of this method suggest that the cost of unused capacity should be treated as a period expense that is disclosed separately on the income statement.

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80 Managerial Accounting, 16th Edition

Problem 2B-3 (continued)

4. Platinum Track’s fundamental problem is the competition that is drawing customers away. The competition is able to offer the latest equipment, excellent service, and attractive prices. The company must do some-thing to counter this threat or it will ultimately face failure.

Under the conventional approach in which the predetermined overhead rate is based on the estimated studio hours, the apparent cost of the Verde Baja job has increased between last year and this year. That hap-pens because the company is losing business to competitors and there-fore the company’s fixed overhead costs are being spread over a smaller base. This results in costs that seem to increase as the volume declines. Under this method, Platinum Track’s managers may be misled into thinking that the problem is rising costs and they may be tempted to raise prices to recover their apparently increasing costs. This would al-most surely accelerate the company’s decline.

Under the alternative approach, the overhead cost of the Verde Baja job is stable at $4,000 and lower than the costs reported under the conven-tional method. Under the conventional method, managers may be mis-led into thinking that they are actually losing money on the Verde Baja job and they might refuse such jobs in the future—another sure road to disaster. This is much less likely to happen if the lower cost of $4,000 is reported. It is true that the cost of unused capacity under the alterna-tive approach is much larger than under the conventional approach and is growing. However, if it is properly labeled as the cost of unused ca-pacity, management is much more likely to draw the appropriate conclu-sion that the real problem is the loss of business (and therefore more idle capacity) rather than an increase in costs.

While basing the predetermined rate on capacity rather than on esti-mated activity will not solve the company’s basic problems, at least this method is less likely to send managers misleading signals.

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Solutions Manual, Appendix 2B 81

Case 2B-4 (120 minutes)

1a. Vault Hard Drives, Inc.

Income Statement: Traditional Approach

Sales (150,000 units × $60 per unit)............ $9,000,000Cost of goods sold:

Variable manufacturing(150,000 units × $15 per unit) ............... $2,250,000

Manufacturing overhead applied(150,000 units × $25 per unit) ............... 3,750,000 6,000,000

Gross margin.............................................. 3,000,000Selling and administrative expenses............. 2,700,000Net operating income.................................. $ 300,000

1b. Vault Hard Drives, Inc.

Income Statement: New Approach

Sales (150,000 units × $60 per unit) ................... $9,000,000Cost of goods sold:

Variable manufacturing(150,000 units × $15 per unit)....................... $2,250,000

Manufacturing overhead applied(150,000 units × $20 per unit)....................... 3,000,000 5,250,000

Gross margin ..................................................... 3,750,000Other expenses:

Cost of unused capacity [(200,000 units –160,000 units) × $20 per unit] ....................... 800,000

Selling and administrative expenses.................. 2,700,000Net operating income ......................................... $ 250,000

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82 Managerial Accounting, 16th Edition

Case 2B-4 (continued)

2. Under the traditional approach, all of the company’s fixed manufacturing overhead must be included in either cost of goods sold (in the income statement) or ending inventory (in the balance sheet) at the end of an accounting period. For each additional unit produced but not sold, it en-ables the company to include an extra $25 of fixed overhead in ending inventory, which in turn lowers the company’s cost of goods sold by $25.

Since the company has net operating income of $300,000 when it pro-duces 160,000 units and sells 150,000 units, it needs to produce enough additional units, beyond 160,000 units, to raise net operating by $200,000 to achieve a desired profit of $500,000. The following compu-tations show that the company would need to produce 8,000 more units (or 168,000 units in total) to achieve net operating income of $500,000.

Additional net operating income required to attain target net operating income ($500,000 – $300,000) (a) ......... $200,000

Fixed overhead applied to each unit of additional inven-tory (b) ..................................................................... $25 per unit

Additional output required to attain target net operating income (a) ÷ (b) ........................................................ 8,000 units

Estimated number of units produced .............................. 160,000 unitsActual number of units to be produced ........................... 168,000 units

* Although overapplied overhead is not explored in detail until the next chapter, astute students may be curious to know that this answer of 168,000 units assumes that the overapplied overhead of $200,000 is closed entirely to Cost of Goods Sold.

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Solutions Manual, Appendix 2B 83

Case 2B-4 (continued)

3. Under the new approach, all of the company’s fixed manufacturing overhead must be included in either cost of goods sold (in the income statement), ending inventory (in the balance sheet), or cost of unused capacity (in the income statement) at the end of an accounting period. For each additional unit produced but not sold, it enables the company to include an extra $20 of fixed overhead in ending inventory, which in turn lowers the company’s cost of unused capacity by $20.

Since the company has net operating income of $250,000 when it pro-duces 160,000 units and sells 150,000 units, it needs to produce enough additional units, beyond 160,000 units, to raise net operating by $250,000 to achieve a desired profit of $500,000. The computations below show that the company would need to produce 12,500 more units (or 172,500 units in total) to achieve net operating income of $500,000.

Additional net operating income required to attain target net operating income ($500,000 – $250,000) (a) ........... $250,000

Fixed overhead applied to each unit of additional inven-tory (b) ....................................................................... $20 per unit

Additional output required to attain target net operating income (a) ÷ (b).......................................................... 12,500 units

Estimated number of units produced ............................... 160,000 unitsActual number of units to be produced ............................ 172,500 units

4. Net operating income is more volatile under the new method than under the old method. The reason for this is that the reported profit per unit sold is higher under the new method by $5, the difference in the prede-termined overhead rates. As a consequence, swings in sales in either di-rection will have a more dramatic impact on reported profits under the new method.

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84 Managerial Accounting, 16th Edition

Case 2B-4 (continued)

5. The “hat trick” is a bit harder to perform under the new method. Under the old method, the target net operating income can be attained by pro-ducing an additional 8,000 units. Under the new method, the production would have to be increased by 12,500 units. Again, this is a conse-quence of the difference in predetermined overhead rates. The drop in sales has had a more dramatic effect on net operating income under the new method as noted above in part (4). In addition, because the prede-termined overhead rate is lower under the new method, producing ex-cess inventories has less of an effect per unit on net operating income than under the traditional method and hence more excess production is required.

6. One can argue that whether the “hat trick” is unethical depends on the level of sophistication of the owners of the company and others who read the financial statements. If they understand the effects of excess production on net operating income and are not misled, it can be ar-gued that the hat trick is not unethical. However, if that were the case, there does not seem to be any reason to use the hat trick. Why would the owners want to tie up working capital in inventories just to artifi-cially attain a target net operating income for the period? And increasing the rate of production toward the end of the year is likely to increase overhead costs due to overtime and other costs. Building up inventories all at once is very likely to be much more expensive than increasing the rate of production uniformly throughout the year. In this case, we as-sumed that there would not be an increase in overhead costs due to the additional production, but that is likely not to be true.

In our opinion, the hat trick is unethical unless there is a good reason for increasing production other than to artificially boost the current pe-riod’s net operating income. It is certainly unethical if the purpose is to fool users of financial reports such as owners and creditors or if the pur-pose is to meet targets so that bonuses will be paid to top managers.

Chapter 02 - Lecture Notes

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Chapter 2

Lecture Notes

Chapter theme: Managers need to assign costs to products

to facilitate internal decision making and external financial

reporting. This chapter illustrates an absorption costing

approach to calculating product costs known as job-order

costing.

Helpful Hint: Briefly review the concepts of fixed and

variable manufacturing costs to help students grasp the

meaning of absorption costing. Mention that total fixed

costs are constant and therefore change on a per unit

basis. Variable costs are proportional to the number of

units produced and are constant on a per unit basis.

I. Job-order costing: an overview

A. Job-order costing systems are used when:

i. Many different products are produced each

period.

ii. Products are manufactured to order.

iii. The unique nature of each order requires tracing

or allocating costs to each job, and maintaining

cost records for each job.

B. Examples of companies that would use job-order

costing include aircraft manufacturers, large-scale

construction companies, and companies that produce

movies.

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II. Job-order costingan example

A. Types of manufacturing costs that are assigned to

products using a job-order costing system:

i. Direct costs

1. Direct materials Traced directly to each job

as the work is performed.

2. Direct labor Traced directly to each job as

the work is performed.

ii. Indirect costs

1. Manufacturing overhead (including indirect

materials and indirect labor). These costs are

allocated to jobs rather than directly traced to

each job.

B. The job cost sheet The accounting department

relies upon a job cost sheet for tracking the direct and

indirect costs associated with a given job.

i. An overview of a job cost sheet for a hypothetical

company called PearCo:

1. A job number uniquely identifies each job.

2. Direct material, direct labor, and

manufacturing overhead costs are

accumulated for each job. 3. The job cost sheet is a subsidiary ledger to the

Work in Process account.

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ii. Measuring direct materials cost

1. Once a sales order has been received and a

production order issued, the Production

Department prepares a materials requisition

form to specify the type, quantity, and total

cost of materials (e.g., $116) to be drawn from

the storeroom, and the job number (e.g., A-

143) to which the cost of the materials is to be

charged.

a. For an existing product, the production

department can refer to a bill of materials to

determine the type and quantity of each item

of materials needed to complete a unit of

product.

2. The Accounting Department records the total

direct material cost of $116 on the appropriate

job cost sheet. Notice, the material requisition

number (e.g., X7-6890) is included on the job

cost sheet to provide easy access to the source

document.

iii. Measuring direct labor costs

1. Workers use time tickets to record the amount

of time that they spent on each job and the total

cost assigned to each job.

2. The Accounting Department records the labor

costs from the time tickets of $120 on to the

job cost sheet.

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iv. Computing predetermined overhead rates

Learning Objective 1: Compute a predetermined

overhead rate.

1. An allocation base, such as direct labor hours,

direct labor dollars, or machine hours, is used

to assign manufacturing overhead to products.

Allocation bases are used because:

a. It is impossible or difficult to trace these

costs to particular jobs (i.e., manufacturing

overhead is an indirect cost).

b. Manufacturing overhead consists of many

different items ranging from the grease used

in machines to the production manager’s

salary.

c. Many types of manufacturing overhead

costs are fixed even though output may

fluctuate during the year.

2. The predetermined overhead rate is

calculated by dividing the estimated amount of

manufacturing overhead for the coming period

by the estimated quantity of the allocation base

for the coming period. Ideally, the allocation

base chosen should be the cost driver of

overhead cost.

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a. Predetermined overhead rates that rely

upon estimated data are often used

because: (1) Actual overhead costs for the period are

not known until the end of the period,

thus inhibiting the ability to estimate job

costs during the period.

(2) Actual overhead costs can fluctuate

seasonally, thus misleading decision

makers.

3. Predetermined overhead rates are calculated

using a four-step process.

a. The first step is to estimate the total amount

of the allocation base required for next

period’s estimated level of production.

b. The second step is to estimate the total fixed

manufacturing overhead cost for the coming

period and the variable manufacturing

overhead cost per unit of the allocation base.

c. The third step is to use a cost formula to

estimate the total manufacturing overhead

cost for the coming period.

d. The fourth step is to compute the

predetermined overhead rate.

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v. Applying manufacturing overhead

Learning Objective 2: Apply overhead cost to jobs

using a predetermined overhead rate.

1. Manufacturing overhead is applied to jobs

using the predetermined overhead rate

multiplied by the actual amount of the

allocation base used completing the job (this is

called a normal costing system). For example,

assume PearCo:

a. Applies overhead to jobs based on direct

labor hours.

b. Estimated that 160,000 direct labor hours

would be required to support the planned

production for the year.

c. Estimated $200,000 of total fixed overhead

cost and $2.75 of variable overhead per

direct labor-hour.

d. Used a cost formula to estimate its total

manufacturing overhead cost of $640,000.

e. Calculated its predetermined overhead rate

of $4 per direct labor hour.

(1) The amount of overhead that would be

applied to the job cost sheet that we

have been working with related to Job

A-143 is $32, calculated as follows:

(a) Eight direct labor hours were

worked on Job A-143.

(b) The predetermined overhead rate

is $4 per direct labor hour.

(c) 8 direct labor hours $4 per hour

= $32.

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Learning Objective 3: Compute the total cost and unit

product cost of a job using a plantwide predetermined

overhead rate.

vi. Completing the job cost sheet

1. The total direct material, direct labor, and

manufacturing overhead costs assigned to Job

A-143 is $268.

a. Since this job included two units, the

average cost per unit is $134. The average

unit cost should not be interpreted as the

costs that would actually be incurred if

another unit was produced.

b. The fixed overhead would not change if

another unit were produced, so the

incremental cost of another unit is

something less than $134.

Quick Check job cost accounting

III. Job-order costing—a managerial perspective

C. Inaccurately assigning manufacturing costs to jobs

adversely influences planning and decisions made by

managers.

i. Job-order costing systems can accurately trace

direct materials and direct labor costs to jobs.

ii. Job-order costing systems often fail to accurately

allocate the manufacturing overhead costs used

during the production process to their respective

jobs.

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D. Choosing an allocation base

i. Job-order costing systems often use allocation

bases that do not reflect how jobs actually use

overhead resources.

ii. The allocation base in the predetermined overhead

rate must drive the overhead cost to improve job

cost accuracy.

1. A cost driver is a factor that causes overhead

costs.

2. Many companies use a single predetermined

plantwide overhead rate to allocate all

manufacturing overhead costs to jobs based on

their usage of direct-labor hours.

a. It is often overly-simplistic and incorrect to

assume that direct-labor hours is a

company’s only manufacturing overhead

cost driver.

b. If more than one overhead cost driver can be

identified, job cost accuracy is improved by

using multiple predetermined overhead

rates.

Learning Objective 4: Compute the total cost and the

unit product cost of a job using multiple predetermined

overhead rates.

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IV. Job-order costing using multiple predetermined

overhead rates

A. A cost system with multiple predetermined

overhead rates uses more than one overhead rate to

apply overhead costs to jobs. For example, assume

Dickson Company uses a job-order costing system

and computes a predetermined overhead rate in each

production department. The company uses cost-plus

pricing to establish selling prices for all of its jobs.

i. Information relating to its two processing

departments is provided on this slide.

ii. The company computes a selling price for Job 407

using a 5-step process:

a. Step 1: Calculate the estimated total

manufacturing overhead cost for each

department:

(1) Milling Department = $390,000 +

($2.00 per MH × 60,000 MHs) =

$510,000.

(2) Assembly Department = $500,000 +

($3.75 per DLH × 80,000 DLHs) =

$800,000.

b. Step 2: Calculate the predetermined

overhead rate in each department:

(1) Milling Department = $510,000 ÷

60,000 MHs = $8.50 per MH.

(2) Assembly Department = $800,000 ÷

80,000 DLHs = $10.00 per DLH.

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c. Step 3: Calculate the amount of overhead

applied from both departments to a job:

(1) Milling Department = $8.50 per MH ×

90 MHs = $765.

(2) Assembly Department = $10.00 per

DLH × 20 DLHs = $200.

d. Step 4: Calculate the total job cost for Job

407:

(1) Total job cost = Direct materials (=

$800 + $370) + Direct labor (= $70 +

$280) + Manufacturing overhead

applied (= $765 + $200) = $2,485.

e. Step 5: Assuming a markup percentage of

75% of total manufacturing cost, calculate

the selling price for the job:

(1) Total job cost of $2,485.00 + Markup

of $1,863.75 (= $2,485 x 75%) =

$4,348.75.

iii. When a company instead creates overhead rates

based on the activities that it performs, it is

employing an approach called activity-based

costing.

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V. Selected topics

A. An external reporting perspective

i. Job-order costing systems are often used to create

financial statements for external parties.

ii. Impact on the income statement when a company

uses predetermined overhead rates:

1. The amount of overhead applied to all jobs

during a period will differ from the actual

amount of overhead costs incurred during the

period.

a. When a company applies less overhead to

production than it actually incurs, it creates

what is known as underapplied overhead.

b. When it applies more overhead to

production than it actually incurs, it results

in overapplied overhead.

2. The cost of goods sold reported on a

company’s income statement must be adjusted

to reflect underapplied or overapplied

overhead.

a. The adjustment for underapplied overhead

increases cost of goods sold and decreases

net operating income.

b. The adjustment for overapplied overhead

decreases cost of goods sold and increases

net operating income.

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iii. Job cost sheets: a subsidiary ledger

1. All of a company’s job cost sheets collectively

form a subsidiary ledger.

2. The job costs sheets provide an underlying set

of financial records that explain what specific

jobs comprise the amounts reported in:

a. Work-in-Process and Finished Goods on

the balance sheet.

b. Cost of Goods Sold on the income

statement.

B. Job-order costing in service companies

i. Although our attention has focused upon

manufacturing applications, it bears re-

emphasizing that job-order costing is also used

in service companies.

1. For example, in a law firm, each client

represents a “job.” Legal forms and similar

inputs represent direct materials. The time

expended by attorneys represents direct labor.

The costs of secretaries, clerks, rent,

depreciation, and so forth, represent the

overhead.

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Chapter 02A - Lecture Notes

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I. Appendix 2A: Activity-Based Absorption Costing

(Slide 1 is the title slide)

Learning Objective 5: Use activity-based absorption

costing to compute unit product costs.

A. Key definitions/concepts

i. Activity-based absorption costing assigns all

manufacturing overhead costs to products

using activity cost pools instead of plantwide

or departmental cost pools.

1. An activity is an event that causes the

consumption of overhead resources.

2. An activity cost pool is a “bucket” in which

costs are accumulated that relate to a single

activity.

3. An activity measure is an allocation that is

used as the denominator for an activity cost

pool.

4. An activity rate is used to assign costs from

an activity cost pool to products.

ii. Activity-based absorption costing differs from

traditional absorption costing in two ways:

1. The activity based approach uses more cost

pools than a traditional approach.

2. The activity-based approach includes some

batch-level and product-level activities and

activity measures that do not relate to the

volume of units produced, whereas the

traditional approach relies exclusively on

volume-related overhead allocation.

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Commented [H1]: Note that the Appendix 2A PPT and LN files

correspond.

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B. Simmons Industries – a traditional approach

i. Assume the following information for the

company as a whole and for its only two

products—deluxe and standard hedge

trimmers.

ii. If we assume that Simmons’ traditional cost

system relies on one predetermined plantwide

overhead rate with direct labor-hours as the

allocation base, then its plantwide overhead

rate ($4.50 per direct labor-hour) would be

computed as shown.

iii. Simmons’ traditional cost system would report

unit product costs as shown. Notice:

1. The deluxe product line is assigned $9.00 of

overhead cost per unit (= 2.0 DLH × $4.50

per hour).

2. The standard product line is assigned $4.50

of overhead cost per unit (= 1.0 DLH ×

$4.50 per hour).

C. Simmons Industries – activity-based absorption

costing

i. Assume that Simmons assigned its $1,800,000

of manufacturing overhead costs to three

activities with expected activity levels as

shown.

ii. The activity rates for each of the three

activities would be computed as shown.

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iii. The overhead cost assignments to the deluxe

and standard product lines are computed as

shown. Notice:

1. All manufacturing overhead has been

assigned to products ($1,130,000 +

$670,000 = $1,800,000).

iv. The activity-based unit product costs for both

product lines are computed as shown. Notice:

1. The manufacturing overhead per unit for

both products is computed by taking the

total overhead assigned to that product and

dividing it by the number of units produced.

D. Simmons Industries – comparing the two approaches

i. The difference in unit product costs between

the two methods is as shown. Notice, the

activity-based unit product cost for the deluxe

(standard) product line is higher (lower) than

what was computed using the traditional cost

system. This is because:

1. The activity-based approach contains two

non-volume-related cost pools—“setting

up machines” which is a batch-level activity

and “parts administration” which is a

product-level activity.

2. The activity-based approach assigned these

costs to products in a way that shifted costs

from the high volume product (standard)

to the low volume product (deluxe).

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I. Appendix 2B: The Predetermined Overhead Rate and

Capacity (Slide #1 is a title slide)

Learning Objective 6: Understand the implications of

basing the predetermined overhead rate on activity at

capacity rather than on estimated activity for the

period.

A. Calculating predetermined overhead rates using an

estimated, or budgeted amount of the allocation

base

i. There two methods of computing predetermined

overhead rates:

1. The first method bases the denominator

volume for overhead rates on the estimated,

or budgeted, amount of the allocation base for the upcoming period.

2. The second method bases the denominator

volume for overhead rates on the estimated

total amount of the allocation base at capacity.

B. Traditional absorption costing

i. Two important limitations from a managerial

accounting standpoint:

1. If predetermined overhead rates are based on

budgeted activity and overhead includes

significant fixed costs, then the unit product

costs will fluctuate depending on the

budgeted level of activity for the period.

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a. This in turn makes it appear as

though the cost of producing the

product has increased, which may

tempt managers to raise prices at the

worst possible time—just as demand

is falling.

2. It charges products for resources that they

don’t use.

a. When the fixed costs of capacity are

spread over estimated activity, the

units that are produced must shoulder

the costs of any unused capacity.

b. If the level of activity falls, a

company’s shrinking output of

products must absorb a growing

share of idle capacity cost that is

above and beyond their actual

production cost.

C. Capacity-based overhead rates

i. The limitations of traditional absorption costing can

be overcome by using “estimated total amount of

the allocation base at capacity” in the denominator

of the predetermined overhead rate calculation

(rather than the “estimated total units in the

allocation base” in the denominator).

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ii. The following example will help distinguish

between these two approaches.

1. Assume that a company leases a piece of

equipment for $100,000 per year. If run at

full capacity, the machine can produce

50,000 units per year.

2. The company estimates that 40,000 units will

be produced and sold next year.

3. The predetermined overhead rate, if based on

the estimated number of units that will be

produced and sold, is $2.50 per unit.

4. The predetermined overhead rate, if based on

capacity, is $2.00.

D. Cost of unused capacity

i. Whenever a company operates at less than full

capacity and allocates fixed overhead costs using a

capacity-based denominator volume it will report

some amount of unused capacity cost.

1. Cost of unused capacity = (Amount of the

allocation base at capacity – Actual amount

of the allocation base) x Predetermined

overhead rate

2. Extending the example, since the company is

operating below capacity, the company’s cost

of unused capacity is $20,000.

E. Income statement preparation

i. The cost of unused capacity should be disclosed

on the income statement prepared for internal

purposes.

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1. Rather than treating it as a product cost (as is

done in the absorption approach), the

capacity-based approach would treat this cost

as a period expense that is reported below

the gross margin.

a. The need to effectively manage

capacity is then highlighted for the

company’s managers.

b. Managers should respond by:

(1). Seeking new business

opportunities that consume the

capacity

(2). Cutting costs and shrinking the

amount of available capacity.

9

Guided Example

Click on links

Exercise 2-2 Apply Overhead Cost to Jobs Exercise 2-2

Exercise 2-3 Computing Total Job Costs and Unit Product Costs Using a Plantwide Predetermined Overhead Rate

Exercise 2-3

Exercise 2-5 Computing Total Job Costs and Unit Product Costs Using Multiple PredeterminedOverhead Rates

Exercise 2-5

Exercise 2-6 Job-Order Costing for a Service Company Exercise 2-6

Exercise 2-7 Job-Order Costing; Working Backwards Exercise 2-7

Exercise 2-8 Applying Overhead Cost; Computing Unit Product Cost Exercise 2-8

Exercise 2-9 Job-Order Costing and Decision Making Exercise 2-9

Chapter 2 – Job-Order Costing: Calculating Unit Product Costs

Guided Example

Exercise 2-2

Guided Example

[LO2]

Garret Corporation uses a predetermined overhead rate of $42.45 per direct labor-hour. This plantwide predetermined rate was based on a cost formula that estimated $7,216,500 of total manufacturing overhead for an estimated activity level of 170,000 direct labor-hours. The company incurred actual total manufacturing overhead costs of $7,110,375 and 165,000 total direct labor-hours during the period.

Required:Determine the amount of manufacturing overhead that would have been applied to all jobs during the period.

Actual direct labor-hours 165,000× Predetermined overhead rate $ 42.45

= Applied manufacturing overhead $7,004,250

Guided Example

Exercise 2-3

Guided Example

[LO3]

Weaver Company’s plantwide predetermined overhead rate is $21.00 per direct labor-hour and its direct labor wage rate is $14.00 per hour. The following information pertains to Job A-200:

Direct materials……………………….$290Direct labor……………………………..$210

Required:1. What is the total manufacturing cost assigned to Job A-200?2. If Job A-200 consists of 50 units, what is the average cost assigned to each unit in the job?

Guided Example

Total direct labor-hours required for Job A-200

Direct labor cost

Direct labor wage rate per hour

Total direct labor-hours

$210

$14

15

$210

÷

Guided Example

Requirement 1: What is the total manufacturing cost assigned to Job A-200?

Direct materials

Direct labor

Manufacturing overhead applied

Total manufacturing cost

$21 per DLH x 15 DLHs

$290

210

315

$815

Manufacturing overhead applied= Predetermined overhead rate per DLH x Jobs Actual Quantity of

DLH

Guided Example

Requirement 2: If Job A-200 consists of 50 units, what is the average cost assigned to each unit in the job?

Direct materials

Direct labor

Manufacturing overhead applied

Total manufacturing cost

$21 per DLH x15 DLHs

$290

210

315

$815

÷ 50Number of units in the job

Unit product cost $16.30

Guided Example

Exercise 2-5

Guided Example

[LO4]

Lionheart Company has two manufacturing departments—Molding and Firing. The predetermined departmental overhead rates in Molding and Firing are $23.00 per direct labor-hour and 150% of direct materials cost, respectively. The company’s direct labor wage rate is $18.00 per hour. The following information pertains to Job HC-916

Required:1. What is the total manufacturing cost assigned to Job HC-916?2. If Job HC-916 consists of 20 units, what is the average cost assigned to each unit in the job?

Molding Firing

Direct materials $290 $340

Direct labor $198 $72

Guided Example

Total direct labor-hours required for Job HC-916

MoldingDirect labor cost $198

Direct labor wage rate per hour $18 Total direct labor hours 11

Guided Example

Requirement 1: What is the total manufacturing cost assigned to Job HC-916?

Manufacturing overhead applied Molding = Predetermined overhead rate per DLH x Actual Quantity of DLH

= $23/DLH x 11

Direct materials $630

Direct labor 270Manufacturing Overhead Molding Department $253Manufacturing Overhead Firing Department 510 763Total manufacturing cost $1,663

Manufacturing overhead applied Firing= Predetermined overhead rate per DM$ x DM$

=150% x $340

Guided Example

Requirement 2: If Job HC-916 consists of 20 units, what is the average cost assigned to each unit in the job?

Total manufacturing cost $1,663Number of units in the job 20

Unit product cost $83.15

Guided Example

Exercise 2-6

Guided Example

[LO1, LO2, LO3]

Smart Strat is an advisory firm that uses a job-order costing system. Its direct materials consist of hardware and software that it purchases and installs on behalf of its clients. The firm’s direct labor includes salaries of advisors that work at the client’s job site, and its overhead consists of costs such as depreciation, utilities, and insurance related to the office headquarters as well as the office supplies that are consumed serving clients.

Smart Strat computes its predetermined overhead rate annually on the basis of direct labor-hours. At the beginning of the year, it estimated that 65,000 direct labor-hours would be required for the period’s estimated level of client service. The company also estimated $445,250 of fixed overhead cost for the coming period and variable overhead of $1.50 per direct labor-hour. The firm’s actual overhead cost for the year was $550,000 and its actual total direct labor was 67,000 hours.

Required:1. Compute the predetermined overhead rate.2. During the year, Smart Strat started and completed the Valencia Company engagement. The

following information was available with respect to this job:

Compute the total job cost for the Valencia Company engagement.

Direct materials $29,000

Direct labor cost $28,500

Direct labor hours worked 300

Guided Example

Requirement:

Compute the company’s predetermined overhead rate for the year.

Component Amount

Estimated fixed overhead $445,250

Estimated variable overhead:

$1.50 per DLH × 65,000 DLHs 97,500

Estimated total overhead cost $542,750

Estimated total overhead $542,750

÷ Estimated total direct labor-hours (DLHs) 65,000 DLHs

= Predetermined plantwide overhead rate $8.35 per DLH

Y = a + bX

Y = $445,250 + ($1.50) (65,000 direct labor-hours)

Guided Example

Requirement 2: Compute the total job cost for the Valencia Company engagement.

Direct materials

Direct labor

Overhead applied

Total cost

$8.35 per DLH x 300 DLHs

$29,000

28,500

2,505

$60,005

Overhead applied= Predetermined manufacturing overhead rate per DLH x Actual Quantity of DLH

Guided Example

Exercise 2-7

Guided Example

[LO1, LO2, LO3]

Ahad Company uses a job-order costing system. Its plantwide predetermined overhead rate uses direct labor-hours as the allocation base. The company pays its direct laborers $16 per hour. During the year, the company started and completed only two jobs—Job Antelope, which used 42,500 direct labor-hours, and Job Zebra. The job cost sheets for the these two jobs are shown below:

Required:1. Calculate the plantwide predetermined overhead rate.2. Complete the job cost sheet for Job Antelope.

Job Antelope

Direct materials ?

Direct labor cost ?

Manufacturing overhead applied ?

Total job cost $1,285,000

Job Zebra

Direct materials $150,000

Direct labor cost 288,000

Manufacturing overhead applied 183,960

Total job cost $621,960

Guided Example

Requirement 1:

Calculate the plantwide predetermined overhead rate.

Direct labor cost $288,000 Direct labor wage rate per hour $16

Total direct labor hours worked 18,000

Manufacturing overhead applied to Job Zebra $183,960 Direct labor hours worked on Job Zebra 18,000

Plantwide predetermined overhead rate $10.22 per DLH

Guided Example

Requirement 2: Complete the job cost sheet for Job Antelope.

Direct materials (plug)

Direct labor

Overhead applied

Total cost

$10.22 per DLH x 42,500 DLHs

$170,650

680,000

434,350

$1,285,000

$16.00 per DLH x 42,500 DLHs

Guided Example

Exercise 2-8

Guided Example

[LO2],[LO3]

Newhard Company assigns overhead cost to jobs on the basis of 140% of direct labor cost. The job cost sheet for Job XN99 includes $19,000 in direct materials cost and $15,000 in direct labor cost. A total of 500 units were produced in Job XN99.

Required:What is the total manufacturing cost assigned to Job XN99? What is the unit product cost for Job XN99.

Guided Example

Requirement : What is the total manufacturing cost assigned to Job XN99? What is the unit product cost for Job XN99.

Direct material $19,000 Direct labor 15,000Manufacturing overhead applied:

$15,000 × 140% 21,000

Total manufacturing cost $55,000

Total manufacturing cost $55,000 Number of units in job 500

Unit product cost $110

Guided Example

Exercise 2-9

Guided Example

[LO1, LO2, LO3, LO6]

Vence Corporation is currently operating at 40% of its available manufacturing capacity. It uses a job-order costing system with a plantwide predetermined overhead rate based on machine-hours. At the beginning of the year, the company made the following estimates:

Required:1. Compute the plantwide predetermined overhead rate.2. During the year, Job 2K17 was started, completed, and sold to the customer for $4,000. The

following information was available with respect to this job:

Compute the total manufacturing cost assigned to Job 2K17.

3. Upon comparing Job 2K17’s sales revenue to its total manufacturing cost, the company’s chief financial officer said “If this exact same opportunity walked through our front door tomorrow, I’d turn it down rather than making it and selling it for $4,000.” Do you agree?

Direct materials $2,100

Direct labor cost $1,265

Machine hours used 90

Machine-hours required to support estimated production 40,000

Fixed manufacturing overhead cost $792,000

Variable manufacturing overhead cost per machine-hour $1.50

Guided Example

Requirement:

Compute the company’s predetermined overhead rate for the year.

Component Amount

Estimated fixed overhead $792,000Estimated variable overhead:

$1.50 per MH × 40,000 MHs 60,000

Estimated total manufacturing overhead cost $852,000

Estimated total overhead $852,000

÷ Estimated total machine hours (MHs) 40,000 MHs= Predetermined plantwide overhead rate $21.30 per MH

Y = a + bX

Y = $792,000 + ($1.50 × 40,000 machine hours)

Guided Example

Requirement 2: Compute the total manufacturing cost assigned to Job 2K17.

Direct materials

Direct labor

Overhead applied

Total cost

$21.30 per MH x 90 MHs

$2,100

1,265

1,917

$5,282

Overhead applied= Predetermined plantwide manufacturing overhead rate per MH

x Actual Quantity of MH

Guided Example

Requirement 3: Prepare some analysis to support or refute the CFO’s position

Sales $ 4,000

Direct materials $2,100 Direct labor 1,265

Manufacturing overhead applied 1,917 5,282

Loss on Job $(1,282)

Sales $ 4,000 Direct materials $2,100

Direct labor 1,265

Variable overhead applied 135 3,500

Contribution margin $ 500

Current machine hours 40,000Current capacity 40%

Machine hours at full capacity 100,000

Estimated fixed overhead $792,000 Estimated total machine-hours 100,000 MHsPredetermined fixed overhead rate $7.92 per MH

Add: variable overhead per MH $1.50 per MHPredetermined capacity overhead rate $9.42 per MH

Sales $ 4,000

Direct materials $2,100 Direct labor 1,265

Overhead applied 848 4,213

Loss on job $ (213)

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Job-Order Costing: Calculating Unit Product Costs

CHAPTER 2

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Job-Order Costing: An Overview

Job-order costing systems are used when:

1. Many different products are produced each period.

2. Products are manufactured to order.

3. The unique nature of each order requires tracing or allocating costs to each job, and maintaining cost records for each job.

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Job-Order Costing: Examples

Examples of companies thatwould use job-order costing include:1. Boeing (aircraft manufacturing)2. Bechtel International (large scale construction)3. Walt Disney Studios (movie production)

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Job-Order Costing – Cost Flow 1

Job No. 1

Job No. 2

Job No. 3

Charge direct material and direct labor

costs to each job as work is

performed.

Direct Materials

Direct Labor

Direct Costs

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Job-Order Costing – Cost Flow 2

Manufacturing Overhead, including indirect

materials andindirect labor,

are allocated to all jobs rather than directly

traced to each job.

Direct Materials

Direct Labor

Job No. 1

Job No. 2

Job No. 3Manufacturing Overhead

Direct Costs

Indirect Costs

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PearCo Job Cost Sheet

Job Number A - 143 Date Initiated 3-4-17

Date Completed

Department B3 Units Completed

Item Wooden cargo crate

Direct Materials Direct Labor Manufacturing Overhead

Req. No. Amount Ticket Hours Amount Hours Rate Amount

Cost Summary Units Shipped

Direct Materials Date Number Balance

Direct Labor

Manufacturing Overhead

Total Cost

Unit Product Cost

The Job Cost Sheet

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Measuring Direct Materials Cost – Part 1

Will E. Delite

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Measuring Direct Materials Cost – Part 2

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Measuring Direct Labor Costs

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Job-Order Cost Accounting

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Learning Objective 1

Compute a predetermined overhead rate.

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Why Use an Allocation Base?

An allocation base, such as direct labor hours, direct labor dollars, or machine hours, is used to assign

manufacturing overhead to individual jobs.

An allocation base, such as direct labor hours, direct labor dollars, or machine hours, is used to assign

manufacturing overhead to individual jobs.

We use an allocation base because:

a.It is impossible or difficult to trace overhead costs to particular jobs.

b.Manufacturing overhead consists of many different items ranging from the grease used in machines to the production manager’s salary.

c.Many types of manufacturing overhead costs are fixed even though output fluctuates during the period.

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The predetermined overhead rate (POHR) used to apply overhead to jobs is determined

before the period begins.

Manufacturing Overhead Application

Estimated total manufacturingoverhead cost for the coming period

Estimated total units in theallocation base for the coming period

POHR =

Ideally, the allocation base is a cost driver that causes

overhead.

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Predetermined overhead rates that rely upon estimated data are often used because:

1. Actual overhead for the period is notknown until the end of the period, thus inhibiting the ability to estimate job costs during the period.

2. Actual overhead costs can fluctuate seasonally, thus misleading decision makers.

The Need for a POHR

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Computing PredeterminedOverhead Rates

The predetermined overhead rate is computed before the period begins using a four-step process.1.Estimate the total amount of the allocation base (the denominator) that will be required for next period’s estimated level of production. 2.Estimate the total fixed manufacturing overhead cost for the coming period and the variable manufacturing overhead cost per unit of the allocation base.3.Use the following equation to estimate the total amount of manufacturing overhead:

4. Compute the predetermined overhead rate.

Y = a + bXWhere,

Y = The estimated total manufacturing overhead costa = The estimated total fixed manufacturing overhead costb = The estimated variable manufacturing overhead cost

per unit of the allocation baseX = The estimated total amount of the allocation base

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Learning Objective 2

Apply overhead cost to jobs using a predetermined

overhead rate.

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Overhead Application Rate

POHR = $4.00 per direct labor-hour

$640,000 estimated total manufacturing overhead

160,000 estimated direct labor hours (DLH)POHR =

PearCo estimates that it will require 160,000 direct labor-hours to meet the coming period’s estimated production level. In addition, the company estimates total fixed manufacturing overhead at $200,000, and variable manufacturing overhead costs of $2.75 per direct labor hour.

Y = a + bXY = $200,000 + ($2.75 per direct labor-hour × 160,000 direct labor-hours)Y = $200,000 + $440,000Y = $640,000

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Recording Manufacturing Overhead

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Learning Objective 3

Compute the total cost and the unit product cost of a job using a

plantwide predetermined overhead rate.

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Calculating Total Cost of Job

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Calculating Unit Product Cost

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Quick Check 1

Job WR53 at NW Fab, Inc. required $200 of direct materials and 10 direct labor hours at $15 per hour. Estimated total overhead for the year was $760,000 and estimated direct labor hours were 20,000. What would be recorded as the cost of job WR53?

a. $200.

b. $350.

c. $380.

d. $730.

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Job WR53 at NW Fab, Inc. required $200 of direct materials and 10 direct labor hours at $15 per hour. Estimated total overhead for the year was $760,000 and estimated direct labor hours were 20,000. What would be recorded as the cost of job WR53?

a. $200.

b. $350.

c. $380.

d. $730.

Quick Check 1a

POHR = $760,000/20,000 hours $38

Direct materials $200

Direct labor $15 x 10 hours $150

Manufacturing overhead $38 x 10 hours $380

Total cost $730

POHR = $760,000/20,000 hours $38

Direct materials $200

Direct labor $15 x 10 hours $150

Manufacturing overhead $38 x 10 hours $380

Total cost $730

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Job-Order Costing – A Managerial Perspective – Part 1

Inaccurately assigning manufacturing costs to jobs adversely influences planning and decisions made by managers.1.Job-order costing systems can accurately trace direct materials and direct labor costs to jobs.

2.Job-order costing systems often fail to accurately allocate the manufacturing overhead costs used during the production process to their respective jobs.

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Job-Order Costing – A Managerial Perspective – Part 2

Choosing an Allocation BaseJob-order costing systems often use allocation bases that do not reflect how jobs actually use overhead resources. The allocation base in the predetermined overhead rate must drive the overhead cost to improve job cost accuracy. A cost driver is a factor that causes overhead costs.

Many companies use a single predetermined plantwide overhead rate to allocate all manufacturing overhead costs to jobs based on their usage of direct-labor hours.

1.It is often overly-simplistic and incorrect to assume that direct-labor hours is a company’s only manufacturing overhead cost driver.

2.If more than one overhead cost driver can be identified, job cost accuracy is improved by using multiple predetermined overhead rates.

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Learning Objective 4

Compute the total cost and the unit product cost of a job using

multiple predetermined overhead rates.

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Information to Calculate Multiple Predetermined Overhead Rates

Dickson Company has two production departments, Milling and Assembly. The company uses a job-order costing system and computes a predetermined overhead rate in each production department. The predetermined overhead rate in the Milling Department is based on machine-hours and in the Assembly Department it is based on direct labor-hours. The company uses cost-plus pricing (and a markup percentage of 75% of total manufacturing cost) to establish selling prices for all of its jobs. At the beginning of the year, the company made the following estimates:

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Step 1 – Calculate the Predetermined Overhead Cost for Each Department

During the current month the company started and completed Job 407. It wants to use its predetermined departmental overhead cost and rate for the Milling and Assembly Departments.

Milling Department = $390,000 + ($2.00 per MH ×60,000 MHs) = $510,000Assembly Department = $500,000 + ($3.75 per DLH ×80,000 DLHs) = $800,000

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Step 2 – Calculate the Predetermined Overhead Rate for Each Department

Use the amounts determined on the previous slide to calculate the predetermined overhead rate (POHR) of each department.

Milling Department = $510,000 ÷ 60,000 MHs = $ 8.50 per MHAssembly Department = $800,000 ÷ 80,000 DLHs = $10.00 per DLH

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Step 3 – Calculate the Amount of Overhead Applied from Both Departments to a Job

Use the POR calculated on the previous slide to determine the overhead applied from both departments to Job 407:

Milling Department = 90 MHs×$8.50 per MH = $765Assembly Department = 20 DLHs×$10 per DLH = $200

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Step 4 – Calculate the Total Job Cost for Job 407

We can use the information given to calculate the amount of the total cost of Job 407. Here is the calculation:

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Step 5 – Calculate the Selling Price for Job 407

It is important to emphasize that using a departmental approach to overhead application results in a different selling price for Job 407 than would have been derived using a Plantwide overhead rate based on either direct labor-hours or machine-hours. The appeal of using predetermined departmental overhead rates is that they presumably provide a more accurate accounting of the costs caused by jobs, which in turn, should enhance management planning and decision making.

The selling price of Job 407 assuming a 75% markup.

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Multiple Predetermined Overhead Rates—An Activity-Based Approach

When a company creates overhead rates based on the activities that it performs, it is employing an approach called activity-based costing.

Activity-based costing is an alternative approach to developing multiple predetermined overhead rates. Managers use activity-based costing systems to more accurately measure the demands that jobs, products, customers, and other cost objects make on overhead resources.

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Job-Order Costing for Financial Statements to External Parties

The amount of overhead applied to all jobs during a period will differ from the actual amount of overhead costs incurred during the period.1. When a company applies less overhead to production than it actually incurs, it creates what is known as underapplied overhead.2. When it applies more overhead to production than it actually incurs, it results in overapplied overhead.

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Financial Adjust for Overhead Applied

The cost of goods sold reported on a company’s income statement must be adjusted to reflect underapplied or overapplied overhead.1.The adjustment for underapplied overhead increases cost of goods sold and decreases net operating income.2.The adjustment for overapplied overhead decreases cost of goods sold and increases net operating income.

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Job Cost Sheets: A Subsidiary Ledger

All of a company’s job cost sheets collectively form a subsidiary ledger.

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Job Cost Sheets: Balance Sheet Reporting

The job costs sheets provide an underlying set of financial records that explain what specific jobs comprise the amounts reported in Work-in-Process and Finished Goods on the balance sheet.

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Job Cost Sheets: Income Statement Reporting

The job costs sheets provide an underlying set of financial records that explain what specific jobs comprise the amounts reported in Cost of Goods Sold on the income statement.

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Job-Order Costing in Service Companies

Although our attention has focused upon manufacturing applications, it bears re-emphasizing

that job-order costing is also used in service industries. Job-order costing is used in many different types of service companies. For example, law firms,

accounting firms, and medical treatment.

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End of Chapter 2

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Activity-Based Absorption CostingAPPENDIX 2A

Appendix 2A-2

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Learning Objective 5

Use activity-based absorption costing to compute unit

product costs.

Appendix 2A-3

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Activity-Based Absorption Costing: Overview

Activity-based absorption costing assignsall manufacturing overhead costs to products

using activity cost pools instead ofplantwide or department cost pools.

Appendix 2A-4

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Activity-Based Absorption Costing: Key Definitions

Key Definitions and Concepts

1. An activity is an event that causes the consumption of overhead resources.

2. An activity cost pool is a “bucket” in which costs are accumulated that relate to a single activity.

3. An activity measure is an allocation that is used as the denominator for an activity cost pool.

4. An activity rate is used to assign costs from an activity cost pool to products.

Appendix 2A-5

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Differences Between ABC Adsorption and Traditional Absorption Costing

Activity-based absorption costing differs from traditional absorption costing in two ways:

1. The activity based approach uses more cost pools than a traditional approach.

2. The activity-based approach includes some batch-level and product-level activities and activity measures that do not relate to the volume of units produced, whereas the traditional approach relies exclusively on volume-related overhead allocation.

Appendix 2A-6

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Simmons Industries – A Traditional Approach

Total estimated manufacturing overhead 1,800,000$

Total estimated direct labor hours 400,000

Deluxe Standard

Direct materials cost per unit 38.00$ 28.00$

Direct labor cost per unit 24.00$ 12.00$

Direct labor hours per unit 2.0 1.0

Units produced 100,000 200,000

Total estimated manufacturing overhead 1,800,000$

Total estimated direct labor hours 400,000

Deluxe Standard

Direct materials cost per unit 38.00$ 28.00$

Direct labor cost per unit 24.00$ 12.00$

Direct labor hours per unit 2.0 1.0

Units produced 100,000 200,000

Simmons Industries provides the following informationfor the company as a whole and for its only two

products—deluxe and standard hedge trimmers.

Appendix 2A-7

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Assuming that Simmons’ traditional cost system relies on one predetermined plantwide overhead

rate with direct labor-hours (DLHs) as the allocation base, then its plantwide overhead rate

is computed as follows:

Predeterminedoverhead rate

= $4.50 per DLH=$1,800,000

400,000 DLHs

Simmons Industries – Calculating POHR

Appendix 2A-8

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Simmons’ traditional cost system would report unit product costs as follows:

2.0 DLH × $4.50 per DLH

1.0 DLH × $4.50 per DLH

Simmons Industries –Applying POH to Products

Appendix 2A-9

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Simmons Industry –Activity-Based Absorption Costing

The ABC project team at Simmons hasdeveloped the following basic information.

Activity and Activity Measures

Estimated

Overhead

Cost

Deluxe Standard Total

Direct labor support (DLHs) 900,000$ 200,000 200,000 400,000

Machine setups (setups) 600,000 400 100 500

Parts administration (part types) 300,000 200 100 300

Total manufacturing overhead 1,800,000$

Expected ActivityActivity and Activity Measures

Estimated

Overhead

Cost

Deluxe Standard Total

Direct labor support (DLHs) 900,000$ 200,000 200,000 400,000

Machine setups (setups) 600,000 400 100 500

Parts administration (part types) 300,000 200 100 300

Total manufacturing overhead 1,800,000$

Expected Activity

Appendix 2A-10

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Simmons Industry –Calculating the Activity Rates

We can calculate the following activity rates:

Activity and Activity Measures

Estimated

Overhead Cost

Total

Expected

Activity

Direct labor support (DLHs) 900,000$ ÷ 400,000 = 2.25$ per DLH

Machine setups (setups) 600,000 ÷ 500 = 1,200$ per setupParts administration (part types) 300,000 ÷ 300 = 1,000$ per part type

Total manufacturing overhead 1,800,000$

Activity Rate

Using the new activity rates, let’s assign overheadto the two products based upon expected activity.

Appendix 2A-11

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Simmons Industry –Total Overhead Assigned to Products

Activity and Activity Measures

Expected

Activity

Activity

Rate

Direct labor support (DLHs) 200,000 × 2.25$ = 450,000$

Machine setups (setups) 400 × 1,200$ = 480,000

Parts administration (part types) 200 × 1,000$ = 200,000

Total overhead cost assigned 1,130,000$

AmountActivity and Activity Measures

Expected

Activity

Activity

Rate

Direct labor support (DLHs) 200,000 × 2.25$ = 450,000$

Machine setups (setups) 400 × 1,200$ = 480,000

Parts administration (part types) 200 × 1,000$ = 200,000

Total overhead cost assigned 1,130,000$

Amount

Deluxe Product

Activity and Activity Measures

Expected

Activity

Activity

Rate

Direct labor support (DLHs) 200,000 × 2.25$ = 450,000$

Machine setups (setups) 100 × 1,200$ = 120,000

Parts administration (part types) 100 × 1,000$ = 100,000

Total overhead cost assigned 670,000$

AmountActivity and Activity Measures

Expected

Activity

Activity

Rate

Direct labor support (DLHs) 200,000 × 2.25$ = 450,000$

Machine setups (setups) 100 × 1,200$ = 120,000

Parts administration (part types) 100 × 1,000$ = 100,000

Total overhead cost assigned 670,000$

Amount

Standard Product

Appendix 2A-12

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Simmons Industry –Calculating Unit Product Cost

Activity-based unit product costs for both product lines

Deluxe Standard

Direct materials cost per unit 38.00$ 28.00$

Direct labor cost per unit 24.00 12.00

Manufacturing overhead per unit 11.30 3.35

Unit product cost 73.30$ 43.35$

Deluxe Standard

Direct materials cost per unit 38.00$ 28.00$

Direct labor cost per unit 24.00 12.00

Manufacturing overhead per unit 11.30 3.35

Unit product cost 73.30$ 43.35$

Appendix 2A-13

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Deluxe Standard

Direct materials cost per unit 38.00$ 28.00$

Direct labor cost per unit 24.00 12.00

Manufacturing overhead per unit 11.30 3.35

Unit product cost 73.30$ 43.35$

Deluxe Standard

Direct materials cost per unit 38.00$ 28.00$

Direct labor cost per unit 24.00 12.00

Manufacturing overhead per unit 11.30 3.35

Unit product cost 73.30$ 43.35$

Simmons Industry –Determining Overhead Per Unit

Activity-based unit product costs for both product lines

$1,130,000 ÷ 100,000 units

$670,000 ÷ 200,000 units

Appendix 2A-14

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Comparing the Two Approaches

Note that the unit product cost of a Standard unitdecreased from $44.50 to $43.35 . . .

. . . while the unit cost of a Deluxe unit increased from $71.00 to $73.30.

Deluxe Standard Deluxe Standard

Direct material 38.00$ 28.00$ 38.00$ 28.00$

Direct labor 24.00 12.00 24.00 12.00

Manufacturing overhead 11.30 3.35 9.00 4.50Unit product cost 73.30$ 43.35$ 71.00$ 44.50$

Activity-Based Costing Traditional Costing

Deluxe Standard Deluxe Standard

Direct material 38.00$ 28.00$ 38.00$ 28.00$

Direct labor 24.00 12.00 24.00 12.00

Manufacturing overhead 11.30 3.35 9.00 4.50Unit product cost 73.30$ 43.35$ 71.00$ 44.50$

Activity-Based Costing Traditional Costing

Appendix 2A-15

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The Two Approaches – Difference in Unit Cost

Note that the unit product cost of a Standard unitdecreased from $44.50 to $43.35, while the unit cost of the

Deluxe unit increased from $71.00 to $73.30.

1. The activity-based approach contains two non-volume-related cost pools –“setting up machines”which is a batch-level activity and “parts administration” which is a product-level activity.

2. The activity–based approach assigned these costs to products in a way that shifted costs from the high volume product (standard) to the low volume product (deluxe).

Appendix 2A-16

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End of Chapter 2A

PowerPoint Authors:Susan Coomer Galbreath, Ph.D., CPAJon A. Booker, Ph.D., CPA, CIACynthia J. Rooney, Ph.D., CPA

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The Predetermined Overhead Rate and CapacityAPPENDIX 2B

Appendix 2B-2

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Learning Objective 6

Understand the implications of basing the predetermined overhead rate on

activity at capacity rather than on estimated activity for the period.

Appendix 2B-3

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The Predetermined Overhead Rate and Capacity—Methods

One method, that we have used, bases the denominator on volume for overhead rates on the estimated, or budgeted, amount of the allocation base for the upcoming period.

A second method, often used for internal management purposes, bases the denominator volume for overhead rates on the estimated total amount of the allocation base at capacity.

For the remainder of this Appendix, we will make two assumptions:(1) all manufacturing overhead costs are fixed; and (2) the estimated, or budgeted, fixed manufacturing overhead at the

beginning of the period equals the actual fixed manufacturing overhead

at the end of the period.

Appendix 2B-4

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Traditional Absorption Costing

There are two significant problems with using the traditional absorption approach from a managerial accounting position.

First, if predetermined overhead rates are based on budgeted activity and overhead includes significant fixed costs, then the unit product costs will fluctuate depending on the budgeted level of activity for the period.

The second limitation of the absorption approach is that it charges products for resources that they don’t use. When the fixed costs of capacity are spread over estimated activity, the units that are produced must shoulder the costs of any unused capacity.

Appendix 2B-5

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Capacity-Based Overhead Rates

The limitations of traditional absorption costing can be overcome by using “estimated total amount of the allocation base at capacity” in the denominator of the predetermined overhead rate calculation (rather than the “estimated total units in the allocation base” in the denominator).

Appendix 2B-6

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Capacity-Based Overhead Rates –Calculations

Maximum, Inc. leases a piece of equipment for $100,000 per year. If run at full capacity, the machine can produce 50,000 units per year. However, the company estimates that 40,000 units will be produced and sold next year.

Predetermined Overhead Rate based on units produced and sold:$100,000

40,000= $2.50 per unit

Predetermined Overhead Rate, if based on capacity, is:$100,000

50,000= $2.00 per unit

Appendix 2B-7

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Cost of Unused Capacity Part 1

Maximum, Inc. leases a piece of equipment for $100,000 per year. If run at full capacity, the machine can produce 50,000 units per year. However, the company estimates that 40,000 units will be produced and sold next year.

Predetermined Overhead Rate based on unit capacity:$100,000

50,000= $2.00 per unit

Let’s calculate the cost of unused capacity using the following equation:

Cost of unused capacity = (50,000 – 40,000) ×$2.00 = $20,000

Appendix 2B-8

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Cost of Unused Capacity Part 2

Cost of unused capacity = (50,000 - 40,000) × $2.00 = $20,000

Cost of unused capacity would be reported on the internal use income statement as an other expense, just like selling and administrative expenses.

Appendix 2B-9

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Managing the Cost of Unused Capacity

Rather than treating it as a product cost (as is done in the absorption approach), the capacity-based approach would treat this cost as a period expense that is reported below the gross margin.a. The need to effectively manage capacity is then highlighted for the company’s managers.b. Managers should respond by:

1) Seeking new business opportunities that consume the capacity.

2) Cutting costs and shrinking the amount of available capacity out to work in process, finished goods, and/or cost of goods sold.

Appendix 2B-10

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End of Chapter 2B